The Atlanta Fed's macroblog provides commentary on economic topics including monetary policy, macroeconomic developments, financial issues and Southeast regional trends.

Authors for macroblog are Dave Altig and other Atlanta Fed economists.

March 05, 2015

Could Reduced Drilling Also Reduce GDP Growth?

Five or six times each month, the Atlanta Fed posts a "nowcast" of real gross domestic product (GDP) growth from the Atlanta Fed's GDPNow model. The most recent model nowcast for first-quarter real GDP growth is provided in table 1 below alongside alternative forecasts from the Philadelphia Fed's quarterly Survey of Professional Forecasters (SPF) and the CNBC/Moody's Analytics Rapid Update survey. The Atlanta Fed's nowcast of 1.2 percent growth is considerably lower than both the SPF forecast (2.7 percent) and the Rapid Update forecast (2.6 percent).

Table 1: Nowcasts of 2015:Q1 real GDP growth

Why the discrepancy? The less frequently updated SPF forecast (now nearly a month old) has the advantage of including forecasts of major subcomponents of GDP. Comparing the subcomponent forecasts from the SPF with those from the GDPNow model reveals that no single factor explains the difference between the two GDP forecasts. The GDPNow model forecasts of the real growth rates of consumer spending, residential investment, and government spending are all somewhat weaker than the SPF forecasts. Together these subcomponents account for just under 1.0 percentage point of the 1.5 percentage point difference between the GDP growth forecasts.

Most of the remaining difference in the GDP forecasts is the result of the different forecasts for real business fixed investment (BFI) growth. The GDPNow model projects a sharp 13.5 percent falloff in nonresidential structures investment that largely offsets the reasonably strong increases in the other two subcomponents of BFI. Much of this decline is due to petroleum and natural gas well exploration; a component which accounts for almost 30 percent of nonresidential structures investment and looks like it will fall sharply this quarter. The remainder of this blog entry "drills" down into this portion of the nonresidential structures forecast (pun intended). (A related recent analysis using the GDPNow model has been done here).

A December macroblog post I coauthored with Atlanta Fed research director Dave Altig presented some statistical evidence that in the past, large declines in oil prices have had a pronounced negative effect on oil and mining investment. Chart 1 below shows that history appears to be repeating itself.

Chart 1: Indicators of drilling activity and oil prices

The Baker Hughes weekly series on active rotary rigs for oil and natural gas wells has plummeted from 1,929 for the week ending November 21 to 1,267 for the week ending February 27. The Baker Hughes data are the monthly source series for drilling oil and gas wells industrial production (IP) and one of the two quarterly source series for the U.S. Bureau of Economic Analysis's (BEA) estimate of drilling investment (for example, petroleum and natural gas exploration and wells). The other source series for drilling investment is footage drilled completions from the American Petroleum Institute, released about a week before the BEA publishes its initial estimate of GDP.

Chart 2: Indicators of oil drilling and natural gas exploration

Chart 2 displays three of these indicators of drilling activity. The data are plotted in logarithms so that one-quarter changes approximate quarterly growth rates. The chart makes clear that the changes in each of the three series are highly correlated, suggesting that the Baker Hughes rig count can be used to forecast the other series. The Baker Hughes data end on February 27, and we can (perhaps conservatively) extrapolate it forward by assuming it remains at its last reading of 1,267 active rigs through the end of the quarter. We can then use a simple regression to forecast the February and March readings of drilling oil and gas wells IP. Another simple regression with the IP drilling series and its first-quarter forecast allows us to project first-quarter real drilling investment. The forecasts, shown as dashed lines in chart 2, imply real drilling investment will decline at an annual rate of 52 percent in the first quarter. This decline is steeper than the current GDPNow model forecast of a 36 percent decline as the latter does not account for the decline in active rotary rigs in February.

A 52 percent decline in real nonresidential investment in drilling would likely subtract about 0.5 percentage point off of first-quarter real GDP growth. However, it's important to keep in mind that a lot of first quarter source data for GDP are not yet available. In particular, almost none of the source data for the volatile net exports and inventory investment GDP subcomponents have been released. So considerable uncertainty still surrounds real GDP growth this quarter.

March 5, 2015 in Energy, Forecasts, GDP | Permalink


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February 23, 2015

Are Oil Prices "Passing Through"?

In a July 2013 macroblog post, we discussed a couple of questions we had posed to our panel of Southeast businesses to try and gauge how they respond to changes in commodity prices. At the time, we were struck by how differently firms tend to react to commodity price decreases versus increases. When materials costs jumped, respondents said they were likely to pass them on to their customers in the form of price increases. However, when raw materials prices fell, the modal response was to increase profit margins.

Now, what firms say they would do and what the market will allow aren't necessarily the same thing. But since mid-November, oil prices have plummeted by roughly 30 percent. And, as the charts below reveal, our panelists have reported sharply lower unit cost observations and much more favorable margin positions over the past three months...coincidence?

photo of Mike Bryan
By Mike Bryan, vice president and senior economist,
photo of Brent Meyer
Brent Meyer, economist, and
photo of Nicholas Parker
Nicholas Parker, economic policy specialist, all in the Atlanta Fed's research department

February 23, 2015 in Energy, Inflation, Pricing | Permalink


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December 04, 2014

The Long and Short of Falling Energy Prices

Earlier this week, The Wall Street Journal asked the $1.36 trillion question: Lower Gas Prices: How Big A Boost for the Economy?

We will take that as a stand-in for the more general question of how much the U.S. economy stands to gain from a drop in energy prices more generally. (The "$1.36 trillion" refers to an estimate of energy spending by the U.S. population in 2012.)

It's nice to be contemplating a question that amounts to pondering just how good a good situation can get. But, as the Journal blog item suggests, the rising profile of the United States as an energy producer is making the answer to this question more complicated than usual.

The data shown in chart 1 got our attention:


As a fraction of total investment on nonresidential structures, spending on mining exploration, shafts, and wells has been running near its 50-year high over the course of the current recovery. As a fraction of total business investment in equipment and structures, the current contribution of the mining and oil sector is higher than any time since the early 1980s (and generally much higher than most periods during the last half century).

In a recent paper, economists Soren Andersen, Ryan Kellogg, and Stephen Salant explain why this matters:

We show that crude oil production from existing wells in Texas does not respond to current or expected future oil prices... In contrast, the drilling of new wells exhibits a strong price response...

In short, the investment piece really matters.

We've done our own statistical investigations, asking the following question: What is the estimated impact of energy price shocks in the second half of this year on investment, consumer spending, and gross domestic product (GDP)?

If you are interested, you can find the details of the statistical model here. But here is the bottom line: the estimated impact of energy price shocks is a very sizeable decline in investment in the mining and oil subsector relative to baseline and, more importantly, an extended period of flat to slightly negative growth in overall investment relative to baseline (see chart 2).


In our simulations, the "baseline" is the scenario without the ex-post energy price shocks occurring in the third and fourth quarters of 2014, while the "alternative" scenario incorporates the (estimated) actual energy price shocks that have occurred in the second half of this year. These shocks lead to a cumulative 8 percent drop in consumer energy prices and a 6 percent drop in producer energy prices by the fourth quarter of this year relative to baseline. By the fourth quarter of 2017, 2 percentage points of these respective energy price declines are reversed. In chart 2 above, each colored line represents the percentage point difference between the "alternative" scenario and the "baseline" scenario.

As for consumption and GDP? Like overall investment, there is a short-run drag before the longer-term boom, as chart 3 shows:


So is the recent decline in energy prices good news for the U.S. economy? Right now our answer is yes, probably—but we may have to be patient.

Note: We have updated this post since it was originally released, clarifying a sentence in the paragraph above chart 2 and providing the data for the charts. The original sentence stated: But here is the bottom line: the estimated impact of energy price shocks is a very sizeable decline in investment in the mining and oil subsector and, more importantly, an extended period of flat to slightly negative growth in overall investment (see chart 2).

December 4, 2014 in Energy, Forecasts, GDP | Permalink


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July 08, 2013

Let’s Talk about Oil

Given its role in touching nearly every aspect of life across the globe and given the higher and volatile prices over the past half-decade, oil supply has been an incessant topic of conversation for much of our recent memory. Yet the tone of the conversation has dramatically pivoted recently from arguments about whether peak oil or sky-high oil prices could spur a global economic meltdown (anyone remember 2008?) to the shifting energy balance as a result of rapidly growing oil production from North America.

Chip Cummins and Russell Gold recently published a piece in the Wall Street Journal discussing how new supply from U.S. shale oil and Canadian oil sands is helping to steady global oil prices.

Crude prices have remained remarkably stable over the past year in the face of a long list of supply disruptions, from Nigerian oil theft to Syrian civil war to an export standoff between Sudan and South Sudan. The reason in large part is a thick new blanket of North American oil cushioning the markets.

This chart helps demonstrate how quickly the oil landscape in the United States has indeed changed. The U.S. Energy Information Administration (EIA) expects national crude oil production to exceed net oil imports later this year, marking a rapid turnaround from the trend of ever-increasing reliance on imports.

However, despite the increase in U.S. oil production, global oil prices have stabilized at relatively high levels, as the chart below shows.

However, the two seemingly opposing narratives—that of high oil prices and that of an emerging oil and gas abundance—are fundamentally linked. In fact, if it hadn’t been for such high oil prices, this new surge in North American oil production may not have happened. It is much more difficult to rationalize drilling activity in deep offshore areas, hard shale, or tar sands—from which, by nature, oil is expensive to produce—without high oil prices. (West Texas Intermediate, or WTI, oil averaged $31 per barrel in 2003, which, even in real terms, is only about 2/5 of today’s prices.) Analysts at Morgan Stanley estimate that the break-even point for Bakken (North Dakota) crude oil is about $70 per barrel and that even a price of $85 per barrel could squeeze out many of the unconventional producers.

What does all this mean for prices? Well, keep in mind that oil is a global commodity. So the roughly two million barrels of oil per day that have entered the market from the U.S. fracking boom represent a big shift domestically but only just over 2 percent of global oil consumption.

And while the United States is seeing growing oil supplies and moderating demand, a different trend is taking place globally, with rising demand from China and other emerging economies coupled with declining supply from older fields and OPEC efforts to keep prices higher through production limits.

However, not everyone believes that higher prices are here to stay. Some analysts have begun to warn that a price crash may be looming. Paul Stevens, an energy specialist with Chatham House, argues that we may be headed for a replay of the price crash in 1986 when high prices triggered demand destruction while bringing new, more expensive sources of supply to the market from the North Sea and Alaska.

Only time will tell where global oil prices will ultimately shake out, but for now, the larger supply cushion has certainly been a welcome development in the United States. Back to the Wall Street Journal article:

The new acting as a shock absorber in a global supply chain that pumps 88 million barrels of oil to consumers each day. That helps everyone from manufacturers to motorists, by steadying fuel prices and making budgeting easier.

Photo of Laurel GraefeBy Laurel Graefe, Atlanta Fed REIN director, and

Photo of LRebekah DurhamRebekah Durham, economic policy analysis specialist at the New Orleans Branch of the Atlanta Fed

Authors’ note: We didn’t touch on the difference between WTI and Brent oil prices in this post, despite the fact that the changing global oil production landscape has undoubtedly contributed to that spread. For those interested, we recommend some recent analysis from the Energy Information Administration on the narrowing spread between WTI and Brent.

July 8, 2013 in Economics, Energy, Pricing | Permalink


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A useful distinction is between the equilibrium price and the spot price which is notoriously volatile, in part, because of geopolitical risks in the Middle East. Increased production sourced in N. America reduces those risks and by adding 'spare capacity' also reduces overall costs by obviating the need for contingency arrangements.

Posted by: van schayk | July 09, 2013 at 12:42 PM

You only briefly mention moderating demand in the US, but the change in demand is about the same as the change in supply (US production). There has been lots of talk about increased production, but very little at the decreased domestic demand. Some of this is due to decreased miles driven, while some is due to higher CAFE standards prompting many new models to have significantly higher mileage than prior models (20% better for Altimas, Mazdas & others). Increased production is important, but reduced demand is equally important, and will be a better long-term solution as we will continue to see improvements as the nationwide fleet improves its mileage.

Posted by: JimC | July 10, 2013 at 09:48 AM

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May 10, 2010

Estimating the oil spill's impact in the Gulf

In this past week's SouthPoint, the Atlanta Fed's regional economics blog, we discussed some of the economics behind the oil spill in the Gulf of Mexico. We were careful to note that determining the impact of the spill is impossible because there are simply too many variables at work: the amount of time before the leaks are capped, the direction of the wind, wave action, water currents, the amount of oil that reaches the coast, the effectiveness of dispersion efforts, the efficiency of clean-up efforts on shore, the amount of federal spending, etc. Measuring the cost of the spill is simply out of reach at the moment.

We can measure the number of jobs at risk, however. Across Florida, Louisiana, Alabama, Mississippi, and Texas—the states likely to be affected most directly—total employment in tourism-related industries and agriculture was about 2.6 million (in 2008), or about 14 percent of total employment in those states. However, if we narrow our scope to metropolitan statistical areas along the Gulf Coast of the most affected states, the numbers are much smaller—just under 132,500—with most being in the accommodation and food services industry.


At the Atlanta Fed, like most Reserve Banks, we not only monitor statistical data, but we also seek out anecdotal information from business contacts within the Southeast. We are hearing mixed reports on hotel cancellations, which could have a significant impact on not only employment in the region but also sales tax revenue. While there has been a flood of inquiries, cancellations are not widespread to date. But some areas are seeing an inflow of clean-up workers into their hotels. Although rather insignificant at this point, it does lead to a larger measurement issue. That is, it's also impossible to measure the degree that clean-up and containment efforts will offset losses in other industries.

Econbrowser estimates the cost of the spill to British Petroleum (BP) by measuring the change in the company's stock price:

"Stock prices give us a yardstick for the markets perception of a company's long run profitability. When an event, such as this oil spill, impacts a company it will also impact its long run profitability. The divergence of the stock price from what we would have expected had the event never happened is a measure of the net present value of the cost incurred by the oil spill. Event study analysis gives us a framework to answer just this question."

While the approach to determining the cost of the spill to BP is much more straightforward than guessing wind and sea currents, it doesn't get to the more complicated endeavor of determining the cost to local communities. For that we will have to wait and see what happens next. Here are some useful links to help keep up with events:

The U.S. Department of the Interior's Minerals Management Service, along with other agencies, has created a Web page dedicated to the Gulf of Mexico oil spill response that features regular updates, maps, and fact sheets. You can also register to receive e-mail notification of updates.

The National Oceanic and Atmospheric Administration is providing coordinated scientific weather and biological response services to federal, state, and local organizations.

A joint effort is under way from the Ocean Circulation Group and the Optical Oceanography Laboratory at the University of South Florida's College of Marine Science  to track and predict the Deepwater Horizon oil spill in the Gulf of Mexico.

The Wall Street Journal is also providing regular updates and coverage.

Finally, the Washington Post published a graphic of the spill and the affected areas of economic activity along the Gulf Coast.

By Mike Chriszt, assistant vice president, and Mike Hammill, economic policy analysis specialist, both in the Atlanta Fed's research department


May 10, 2010 in Energy | Permalink


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September 09, 2008

Hurricanes put energy on center stage

Hurricane season is in full swing here in the Southeastern United  States. The Atlanta Fed pays particular attention to hurricanes for two reasons: (1) they have significant impacts on the local economies they strike, and (2) they can potentially have big impacts on the national economy.

For example, in 2005, even though the Katrina and Rita storm-damaged area of Louisiana represented only a small fraction of the nation’s gross domestic product (GDP), it cast an outsized shadow because of its very large role in oil and gas production and processing. Katrina and Rita’s disruptions of this production and processing spilled over into the national economy, destroying 113 offshore oil and gas platforms and damaging 457 oil and gas pipelines. This damage generated uncertainty about the availability and price of energy products, causing prices to immediately jump.

After relatively quiet hurricane seasons in 2006 and 2007, 2008’s hurricane season thus far has been quite active, with potentially significant national implications. That’s because the Gulf of Mexico remains a substantial source of oil and natural gas production—just as it was three years ago. In addition, coastal Louisiana is the home to upwards of 50 chemical plants, which produce 25 percent of the nation's chemicals that are used in a wide variety of products such as medicines, fertilizers, and plastics. Compounding the Gulf Coast’s concentration of oil, gas and chemicals is the fact the U.S. economy is in a weaker state today and, as a result, more vulnerable to economic shocks than in 2005, a point made in a recent CNNMoney article about Hurricane Gustav.

One of the questions we are often asked is, “what is the effect of a hurricane on the economy?” Not surprisingly, the answer depends on what “the economy” refers to. From a national accounting perspective, GDP is a measure of the nation’s current production of goods and services; thus GDP is not directly affected by the loss of property (structures and equipment) produced in previous periods.

However, there are usually second-round GDP effects that arise because of disruptions to production, income and consumption flows. The Bureau of Economic Analysis provides a good description. For example, in the short run after a hurricane, incomes in many industries are likely to decline because of cuts in production, while some industries involved in the cleanup and repair may see activity increase. Similarly, incomes and spending could increase in areas that are the recipients of evacuees. The net effect of these flow disruptions on GDP over time is often not large because lost output from destruction and displacement is offset by a big increase in reconstruction and public spending later.

But even if the effects are neutral on a national scale a storm’s impact can be long-lasting in an affected locale. For instance, the flooding associated with Katrina left the economy of New Orleans devastated, and in many dimensions it has not fully recovered three years after the storm. Air traffic through New Orleans International Airport increased 13 percent in June 2008 compared to a year earlier but still remained well below pre-Katrina levels. Hurricane Gustav resulted in another evacuation of the city and the cancellation of numerous tourist and other events. Clearly storms like this have the potential to wreak havoc on the prosperity of the Crescent City.

The Atlanta Fed regularly reports on regional economic conditions on its public Web site. As part of its efforts to monitor storm effects—both local and national—the Atlanta Fed is also providing information on post-storm conditions in the affected areas. So far, these reports have focused on Hurricane Gustav’s impact on key energy and transportation infrastructure. The Bank will provide similar updates on other storms, including Hurricane Ike, which had entered the Gulf of Mexico at the time of this posting.

By John Robertson and Mike Chriszt in the Atlanta Fed’s research department

Note: Macroblog will not feature postings on monetary policy issues during the Federal Open Market Committee meeting blackout period, which runs from the week before the FOMC meeting until the Friday after it. Also, David Altig, senior vice president and research director of the Atlanta Fed, will not post during this time frame.

September 9, 2008 in Energy, Katrina | Permalink


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Interesting that you should bring up hurricanes.

Those who claim that the Fed must only conduct monetary policy using linear/quadratic models (apparently Buiter among them?) would confine the Fed to models that assert that shocks hitting the economy are distributed in a Gaussian manner.

Mainstream Fed thought seems to understand that this is demonstrably false. I view it as asinine.

I wonder if those people who shout so loud that the Fed needs to use models that assume a normal distribution of shocks throughout the economy as a guide for open market operations similarly claim that shocks from a HURRICANE are normally distributed along its path......

Indeed, the similarities between economic shocks and hurricanes may not be a trivial one mathematically. Picking up momentum over water, etc.

And the damage that a hurricane causes is obviously skewed in various ways, depending on so many factors.

An interesting mathematical metaphor.

Matt Dubuque

Posted by: Matt Dubuque | September 09, 2008 at 09:12 PM

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May 08, 2007

Pump It Up

From Reuters, the unhappy news that you already knew:

U.S. average retail gasoline prices rose to an all-time high over the past two weeks, due to a number of refinery outages, according to the latest nationwide Lundberg survey.

The national average price for self-serve regular unleaded gas was $3.0684 a gallon on May 4, an increase of 19.47 cents per gallon in the past two weeks, according to the survey of about 7,000 gas stations.

The prior all-time record was an average price of $3.0256 per gallon, that was reached on August 11, 2006.

One of the first things you learn in macro class is that these sort of figures can be extremely misleading if you don't adjust for inflation, so kudos to the Reuters folks for this:

However, the current price is 6.4 cents short of the inflation-adjusted high that was reached in March of 1981, at that time regular grade self serve gasoline was $1.35 per gallon, but on an inflation-adjusted basis today that would translate into $3.13 per gallon.

That said, feel free to file current gas prices in the "ouch" category. 

We were certainly warned this was coming, but maybe by now the worst is over?  A ray of hope from the Wall  Street Journal's Energy Roundup:

Crude-oil futures dropped to their lowest level in almost seven weeks and appeared ready to extend their five-session loss of nearly 7%. Traders were betting that U.S. data, due later this week, will reveal ample supplies of crude and little or no decline in product inventories...

John Person, president of, attributed the recent price weakness to “massive hedge-fund liquidation.” He points out that the Commodities Futures Trading Commission report shows non-commercial traders are long by a net 65,000 contracts and commercial traders are net short.

At the same time, he said, “last week’s tensions eased regarding Iran’s nuclear program, and as refineries come back on line, we are expecting gasoline supplies to build. Crude-oil inventories have climbed in recent weeks, so there is plenty of [inventory]. … [And] if refineries do get back up to speed, we will potentially see gasoline builds in the next few weeks.”

That last sentence is a big "if", and Mr. Person does advise you to temper the celebration:

Even so, Person said he doesn’t expect a massive decline in prices or any break below $58.

Hey, we can dream can't we?

UPDATE: The Energy Information Administration's update provided no comfort:

Continuing problems for refineries in the United States and abroad, combined with strong global gasoline demand, have raised our projected average summer gasoline price by 14 cents per gallon from our last Outlook.  Retail regular grade motor gasoline prices are now projected to average $2.95 per gallon this summer compared with the $2.84 per gallon average of last summer.   During the summer season, the average monthly gasoline pump price is projected to peak at $3.01 per gallon in May and again in August, compared with $2.98 per gallon last July.

May 8, 2007 in Energy | Permalink


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If we don't think, act accordingly & accept responsibly for our actions, what else can we do but dream? Is there NO connection between the policies of our twice-elected GWB & the increases we've seen in oil/gas prices?

Posted by: bailey | May 08, 2007 at 08:11 AM

With the greatest of respect i posit no relationship between the policies of George bush Jr and the steep rise in the price of oil.Succinctly stated the chines and the indians are building modern industrial takesa lot of energy to build them And woe to you who ignore the outcome as everything they build(almost) is petrolem intensive.i dont care whoinhabits the white house petroleum is going to cost more in the near term and the forseeable long term.JJJ

Posted by: jjj | May 08, 2007 at 11:51 AM

With the greatest of respect i posit no relationship between the policies of George bush Jr and the steep rise in the price of oil.Succinctly stated the chines and the indians are building modern industrial takesa lot of energy to build them And woe to you who ignore the outcome as everything they build(almost) is petrolem intensive.i dont care whoinhabits the white house petroleum is going to cost more in the near term and the forseeable long term.JJJ

Posted by: jjj | May 08, 2007 at 11:52 AM

I sometimes have a bit if a titter if the prices of gas in eth states. here in the UK a gallon of feul is over £5 a gallon, at todays rate that is equivelent to $10 a gallon. yet here in the UK we also have our own reserves.


Posted by: AA Breakdown | May 08, 2007 at 03:29 PM

Nice Mae West wasn't that long ago when oil prices would do something to the likes of Stephen Roach's blood pressure.

Dwindling North Sea reserves, no AA?
But this mention of "refinery outages" to describe the disconnect between crude price and gas pump...
and this... "Traders were betting that U.S. data, due later this week, will reveal ample supplies of crude and little or no decline in product inventories..."
and this...", “last week’s tensions eased regarding Iran’s nuclear program, and as refineries come back on line, we are expecting gasoline supplies to build." (Don't underestimate the tension on my clothes line either while we're at it: shooting with abandon as to why gas prices could be so high with healthy crude inventory.)

The fact that this is not making much news worries the crap out of me. Pump it up. What the hell, this late in the the general feeling of powerlessness.

Posted by: calmo | May 08, 2007 at 10:24 PM

For what it's worth, according the inflation calculator on the BLS website, $1.35 in 1981 has the purrchasing power of $3.05 today, so the $3.06 per gallon is an all-time high....assuming we can believe BLS

Posted by: Mark Lieberman | May 10, 2007 at 08:43 AM

For decades we had excess capacity in the oil refining industry. So it was an unprofitable business and refining margins remained very depressed and no one would build a new refinery. Now we have used up that excess capacity and refiners are finally starting to build margins and become profitable.As a consequence after 20 to 30 years of the spread between crude oil and gas prices being essentially a constant it is now changing.
If we are not careful someone might actually respond to these market signals and build a new refinery.

Posted by: spencer | May 10, 2007 at 12:12 PM

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April 25, 2007

Some Inconvenient Truths

The Financial Times has uncovered some stumbling blocks on the road to carbon neutrality.  Its multi-part report starts with a useful tutorial:

Offsetting is a fundamental principle of the Kyoto protocol – an agreement among more than 160 countries that came into force in 2005. It allows developed nations to meet emissions reduction targets by funding projects such as wind farms or solar panels in poorer countries through the so-called “clean development mechanism”. This awards such projects “carbon credits”. The credits, which can be traded on the international carbon markets, sell for between $5 and $15 (€3.66-€11, £2.50-£7.50) per tonne of carbon dioxide. To aid comparison, other greenhouse gases – such as nitrous oxide and methane – are measured as equivalents of CO2.

Carbon markets have grown rapidly since they were brought into being by the Kyoto treaty and the start of the European Union’s emissions trading scheme in 2005, under which companies were issued with tradeable permits to emit carbon. The price of carbon in the EU scheme more than halved last year after it was revealed that more permits had been issued than were needed in the first phase, from 2005 to 2007.

In the first nine months of 2006, according to the United Nations and World Bank, up to $22bn of carbon was traded. About $18bn of this was through the EU’s emissions trading scheme, and $3bn through the Kyoto mechanism.

The third element, the voluntary market, is where most offsets are bought. Businesses participating in this are not bound to reduce emissions, unlike companies under the EU trading scheme or governments under Kyoto. In 2005, the World Bank estimates, the voluntary market formed under 1 per cent of global dealings, trading fewer than 10m tonnes of carbon a year. But by 2010, the consultancy ICF International forecasts it will grow 40-fold to be worth $4bn.

Most companies going carbon-neutral use intermediaries to buy offsets on their behalf.

According to the FT, however, all has not gone well:

The FT investigation found:

■ Widespread instances of people and organisations buying worthless credits that do not yield any reductions in carbon emissions.

■ Industrial companies profiting from doing very little – or from gaining carbon credits on the basis of efficiency gains from which they have already benefited substantially.

■ Brokers providing services of questionable or no value.

■ A shortage of verification, making it difficult for buyers to assess the true value of carbon credits.

■ Companies and individuals being charged over the odds for the private purchase of European Union carbon permits that have plummeted in value because they do not result in emissions cuts.

In the end, the FT editors conclude that it's time to join the Pigou club:

The Kyoto protocol to fight climate change expires in 2012. The shape of a successor treaty is still in doubt, but one aspect seems certain: carbon trading will play a major role. A Financial Times investigation today reveals that carbon markets leave much room for unverifiable manipulation. Taxes are better, partly because they are less vulnerable to such improprieties.

I'm waiting to hear a good case made to the contrary.

UPDATE:  More on the topic, from Greg Mankiw and from Felix Salmon.

UPDATE AGAIN: Yet more at Reviving Economics: Here, here, and here.

April 25, 2007 in Energy, This, That, and the Other | Permalink


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A carbon tax program is not going to eliminate the problems with compliance and monitoring. You still need to figure out who is polluting and by how much, and to verify any claims of output reduction. This has to occur within a multinational framework where many countries are going to be motivated to cheat and to assist their local industries. The system doesn't regulate itself.

Another big question with taxes is whether there would be tax credits for projects that sequester carbon. From the policy perspective, this is desirable: if someone can come up with a cost-effective technology to remove carbon from the air, we would want to reward them. If everyone else has to pay to put carbon into the air, they should get paid to remove carbon from the air.

But once we do this, I think we would see many of the same problems of abuse and misdirection that have bedeviled the carbon credit program. If someone is planting a forest and wants to claim a tax credit, how do we know that the trees are really going to be allowed to grow for the next 50 years? Particularly in the third world, the institutions necessary for accountability and monitoring just do not exist.

While a Pigouvian carbon tax does make economic sense and is probably simpler to implement than cap and trade, it is far from a simple fix. Advocates should be prepared to face the same kinds of messes and problems that the EU carbon trading system has run into in its first years.

Posted by: Hal | April 26, 2007 at 12:41 PM

I forgot to mention another problem with a carbon tax: setting the level. The paradox is that setting the carbon tax rate at a level corresponding to economic estimates of future harm will probably not produce significant reductions in greenhouse gases.

A commonly bandied about figure is $100 per ton of carbon. This is actually rather high compared to most analyses. (Tol[1] reviewed the literature in 2005 and found that $14/tC was the median among over 100 studies, with higher quality studies producing lower values.) The Stern report did come up with a higher number but that is something of an outlier and has been criticized for unreasonably low discount rates[2].

But even if we use $100/tC, that is only about 20 cents a gallon of gasoline. That's going to be a drop in the bucket compared to existing European gasoline taxes. And even in the U.S. it's largely going to be lost in the noise of our month to month gas price fluctuations. I can't believe that an extra 20 cent gas tax is going to force anyone to conserve significantly or change their habits to reduce CO2 emissions.

It may be easy to sign up for the Pigou tax program, but when it is time to bell the cat and put a number on the table for the cost to put a ton of carbon into the air, I think we're going to see a lot less agreement. It's pretty tough to come up with a number that is both scientifically defensible as a cost, and which will also lead to realistic CO2 reductions.


Posted by: Hal | April 26, 2007 at 12:56 PM


the short-run elasticity e.g. of gasoline demand with respect to the gasoline price maybe very low, but the long-run effects are much more pronounced. Although it will not likely reduce the mileage, it will definitely make buyers shift toward more efficient cars. The difference between U.S. and Europe does not need to be mentioned. It's like with the recent hike with gasoline prices - it had a deniable effect for the moment, but I bet that people think much more about fuel consumption when they get their new car.

A similar development is likely to be seen in the energy efficiency of housing, an area where there are even higher reserves, I believe.

Having said that, I have to agree with you that 20 cents per gallon (I am relying here on your claim) is very small. In this respect, the increases in market prices will have a much stronger impact. (I was tempted to write "were much better", but did not, since I am not convinced at all what is "better" in this game).

Posted by: pinus | April 26, 2007 at 01:31 PM

Taxes at the point of production of coal, oil, and natural gas should be moderately simple. Other pollutants, even water vapor, should be considered but unless concentrated would probably not be workable. Subsidies for technologies that lower demand and increase efficiency should be more substantial, measurable, and concentrated. Sequestration is more difficult as all the energy inputs must considered and are often difficult to measure. Many actions may have impacts which are nearly incalcuable.

Posted by: Lord | April 26, 2007 at 03:19 PM

Hal -- Your points are well taken. Conceptually the cap-and-trade system will look like some sort of equivalent tax scheme, as Greg Mankiw points out. You note the issue with tax credits, and that does seem to be part of the problem. By way of analogy, think about a tax policy designed to increase saving. We can either tax consumption or subsidize saving. We can construct these policies so that they are in an abstract sense equivalent, but with the latter it might be harder to eliminate loopholes that merely involve shifting around behavior. (Think tax-preferred accounts vs other forms of saving.) I could be wrong, but I take it from the FT article that this is what is happening to some degree with the carbon-trading system. Perhaps there is a way to construct the trading system that avoids that particular problem, but it seems easy with a tax system -- just don't go down the road of crediting particular types of activity (inputs) and focus on outputs. Not easy to do, but it seems to me that applies to both approaches more or less equally once a trading system involves caps.

Posted by: Dave Altig | April 28, 2007 at 09:53 AM

Another issue with regard to a Pigou tax, which is touched on in some of the articles you link to, is what to do with the embarrassing windfall of tax revenues. Classic Pigovian theory would be to rebate them to the public more or less evenhandedly. In practice everyone seems to feel that they have better ideas, whether Mankiw's reduction of corporate income taxes or alternative proposals to boost renewable fuel research.

Actually we in the U.S. are lucky. Since carbon pollution is a global problem, it needs to be solved on a global level. A global Pigouvian tax of say $100/tC would collect $200 billion/year in the U.S. based on per capita U.S. emission of about 7 tC/year. Since worldwide average emission levels are only about 1.4 tC/yr, 80% of the U.S. tax receipts should be distributed to the 100-odd countries which emit less than the global average. This $160 billion will make a nice supplement to our existing foreign aid budget of $15 billion and will no doubt be welcomed by the third world.

The bottom line is that to really do Pigou right most Western countries will have to divert the great majority of these new tax revenues to the poor countries of the world which are getting harmed by global warming caused by the rich. It is plainly equitable, but given the relatively modest funding levels foreign aid has achieved in the past it is questionable how well this will go over as part of the Pigou package.

Carbon numbers from (dividing by 3 since that page shows CO2 rather than C emissions).

Posted by: Hal | April 29, 2007 at 02:47 AM

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April 04, 2007

No Relief At The Pump -- For Now

If you read Lynne Kiesling today you will receive some very good advice to go pay the Wall Street Journal's Energy Roundup blog a visit. And if you follow that advice, you will find yet more good advice, this time in the form of a link to a item on "This Week in Petroleum" at R-Squared Energy Blog. And from there you will be informed of this story, from CNN Money:

... the Energy Information Administration said gasoline stocks, closely watched ahead of the summer driving season, plummeted by 5 million barrels. Analysts were looking for a small drop of just 300,000 barrels, according to Reuters.

The fall in gasoline supplies pushed gasoline stocks to the lower end of their average range, the first time in several months the supplies have dipped below average...

"We're nowhere near where we should be in terms of inventories," said John Kilduff, an energy analyst at Fimat in New York, who also pointed to strong gasoline demand numbers in the report. "We're seeing the kind of numbers we only see during the peak summer season."

Kilduff also noted the relatively low rate of refinery operation, which EIA said was at 87 percent capacity last week.

"The failure of the refinery rate to go to 90 percent is spelling lots of trouble for us," he said.

From the Energy Information Administration report:

For years, the typical summer driving season was considered to occur between the Memorial Day and Labor Day holidays, with peak summer gasoline demand occurring sometime after the Fourth-of-July holiday. While this characterization still holds, in recent years, demand patterns have shifted somewhat to include more robust levels of gasoline demand earlier in the season with a pre-summer peak in gasoline prices.

Add it up and what do we get?  One more stress point for the economy in the near-term, and hopeful thinking about what the rest of the year will bring:

Consequently, as gasoline demand began to grow in earnest in April, gasoline supply has failed to keep pace, resulting in continued significant stock declines and sharp upward pressure on gasoline prices in recent weeks. Nevertheless, while the short term outlook for gasoline markets appears to be tight, the longer term outlook remains unclear. Thus, spring breakers will most likely notice higher gasoline prices during April, compared with last year. Following spring break, however, Memorial Day, Independence Day, and Labor Day vacationers may face different, possibly softer, markets.

Somehow I just dont find an "unclear" outlook and "possibly softer, markets" all that comforting.

Side note:  For a discussion of new research on the historical effect of oil price changes on economic growth, check out Econbrowser.   

April 4, 2007 in Energy | Permalink


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I'm glad that you raised this issue.

I was in the North Georgia and North Carolina mountains during the past few weeks (ok, small mountains for those out West or in Europe). Sherry was busy trying her best to kill me while hiking to all those unidentified secret waterfalls. (I'm convinced that she will eventually achieve success on this effort.)

I noticed something that I had never encountered before at this time of year. There was no 87 and 89 octane available for a few days at stations along a 30 mile trek that we normally travel. Note, of course, that this occurred prior to the beginning of the prime tourist season which kicks off on 9 April.

So, I asked what was up. The station operators were surprised, as they had no advance notice on the shortfall in replinishing their tanks.

Yeah, I poured 93 octane into the the new four wheel drive Suburban and trudged on down the road.

Admittedly, my fuel economy improved slightly. It should for the price difference.

Ah, life in the hills of North Georgia. Waterfall bound.

Posted by: Movie Guy | April 05, 2007 at 01:47 AM

Oh, yeah - I have a killer humor piece for you.

Do pass it along.


Texas Chili Cook-Off

If you can read this whole story without laughing, then there's no hope for you. I was crying by the end. This is an actual account as relayed to paramedics at a chili cook-off in Texas.

If you pay attention to the first two judges, the reaction of the third judge is even better. For those of you who have lived in Texas, you know how true this is. They actually have a Chili Cook-off about the time Halloween comes around. It takes up a major portion of a parking lot at the San Antonio City Park. Judge # 3 was an inexperienced Chili taster named Frank, who was visiting from Springfield, IL.


Frank: "Recently, I was honored to be selected as a judge at a chili cook-off. The original person called in sick at the last moment and I happened to be standing there at the judge's table, asking for directions to the Coors Light truck, when the call came in. I was assured by the other two judges (Native Texans) that the chili wouldn't be all that spicy; and, besides, they told me I could have free beer during the tasting, so I accepted and became Judge 3."

Here are the scorecard notes from the event:

Judge # 1 -- A little too heavy on the tomato. Amusing kick.
Judge # 2 -- Nice, smooth tomato flavor. Very mild.
Judge # 3 (Frank) -- Holy crap, what the hell is this stuff? You could remove dried paint from your driveway. Took me two beers to put the flames out. I hope that's the worst one. These Texans are crazy.

Judge # 1 -- Smoky, with a hint of pork. Slight jalapeno tang.
Judge # 2 -- Exciting BBQ flavor, needs more peppers to be taken seriously.
Judge # 3 -- Keep this out of the reach of children. I'm not sure what I'm supposed to taste besides pain. I had to wave off two people who wanted to give me the Heimlich maneuver. They had to rush in more beer when they saw the look on my face.

Judge # 1 -- Excellent firehouse chili. Great kick.
Judge # 2 -- A bit salty, good use of peppers.
Judge # 3 -- Call the EPA. I've located a uranium spill. My nose feels like I have been snorting Drano. Everyone knows the routine by now. Get me more beer before I ignite. Barmaid pounded me on the back, now my backbone is in the front part of my chest. I'm getting sh*t-faced from all of the beer.

Judge # 1 -- Black bean chili with almost no spice. Disappointing.
Judge # 2 -- Hint of lime in the black beans. Good side dish for fish or other mild foods, not much of a chili.
Judge # 3 -- I felt something scraping across my tongue, but was unable to taste it. Is it possible to burn out taste buds? Sally, the beer maid, was standing behind me with fresh refills. This 300 lb. woman is starting to look HOT ... just like this nuclear waste I'm eating! Is chili an aphrodisiac?

Judge # 1 -- Meaty, strong chili. Cayenne peppers freshly ground, adding considerable kick. Very impressive.
Judge # 2 -- Chili using shredded beef, could use more tomato. Must admit the cayenne peppers make a strong statement.
Judge # 3 -- My ears are ringing, sweat is pouring off my forehead and I can no longer focus my eyes. I farted, and four people behind me needed paramedics. The contestant seemed offended when I told her that her chili had given me brain damage. Sally saved my tongue from bleeding by pouring beer directly on it from the pitcher. I wonder if I'm burning my lips off. It really ticks me off that the other judges asked me to stop screaming. Screw them.

Judge # 1 -- Thin yet bold vegetarian variety chili. Good balance of spices and peppers.
Judge # 2 -- The best yet. Aggressive use of peppers, onions, garlic. Superb.
Judge # 3 -- My intestines are now a straight pipe filled with gaseous, sulfuric flames. I crapped on myself when I farted, and I'm worried it will eat through the chair. No one seems inclined to stand behind me except that Sally. Can't feel my lips anymore. I need to wipe my butt with a snow cone.

Judge # 1 -- A mediocre chili with too much reliance on canned peppers.
Judge # 2 -- Ho hum, tastes as if the chef literally threw in a can of chili peppers at the last moment! **I should take note that I am worried about judge number 3. He appears to be a bit of distress as he is cursing uncontrollably.
Judge # 3 -- You could put a grenade in my mouth, pull the pin, and I wouldn't feel a thing. I've lost sight in one eye, and the world sounds like it is made of rushing water. My shirt is covered with chili, which slid unnoticed out of my mouth. My pants are full of lava to match my shirt. At least during the autopsy, they'll know what killed me. I've decided to stop breathing. It's too painful. Screw it; I'm not getting any oxygen anyway. If I need air, I'll just suck it in through the 4-inch hole in my stomach.

Judge # 1 -- The perfect ending, this is a nice blend chili. Not too bold but spicy enough to declare its existence.
Judge # 2 -- This final entry is a good, balanced chili. Neither mild nor hot. Sorry to see that most of it was lost when Judge #3 farted, passed out, fell over and pulled the chili pot down on top of himself. Not sure if he's going to make it. Poor feller, wonder how he'd have reacted to really hot chili?
Judge # 3 - No Report

Posted by: Movie Guy | April 05, 2007 at 01:59 AM

Let's blame it on daylight savings time.

Posted by: Lord | April 06, 2007 at 11:22 AM

You can fool some of the people some time but you cant fool all the people allof the time these numbers that are put out to the public are nothing but bull shit and you can take that to the bank. As long as we have money there will be plenty of gas at the pumps. When they put this country into the poor house then it will be to late the hogs are feeding at the trough and there is no end to their greed.

Posted by: art miller | April 08, 2007 at 07:33 PM

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January 08, 2007

Are We Really Less Dependent On Oil?

Austin Goolsbee made a little noise last week, writing in the New York Times that the answer is yes:

... the data shows that much has changed since the wrenching days of the 1970s, for American industry at least. The energy used for each dollar of gross domestic product in 1980 was almost 70 percent greater than it is today. While we have collectively wrung our hands over the decline of manufacturing in the country, it has also reduced the relationship between energy prices and growth.

Greg Mankiw accepts the claim that

... energy prices have a smaller impact today than they did in the past.

... and Mike Moffatt was prompted to muse:

The relationship between the decline of manufacturing in the United States and the reliance on foreign oil is an interesting one.

The facts are the facts on the fairly dramatic increase in energy efficiency in US production, but if there has been a declining impact on economic activity, that looks like a fairly recent development:




The shaded bars in that picture are NBER recession dates. You only have to go back a few years -- to the 2001 recession -- to find a significant energy shock looking for all the world like the partner of an economic downturn.  Just like the four recessions that preceded it.

Of course, as I have noted here before, it's possible that the correlation of energy price spikes and recessions in the 70's, 80s, and 90s was just a coincidence. But it's also possible that the run up in energy prices over the past five years has indeed had a significant negative impact on economic activity, despite the fact that the tipping point into recession has not yet arrived.  Let's call the effect of energy shocks on the economy an open question. 

As for a decline in dependence on foreign oil, it hasn't happened.  Here's an updated version of a picture I showed some time ago, capturing energy consumption relative to GDP versus production relative to GDP:




As I wrote in my earlier post:

As we entered the latest series of oil shocks in 2002, energy efficiency -- measured by the quantity of energy usage per inflation-adjusted dollar of GDP -- had fallen significantly from 1970s levels.  Energy dependence -- measured by the gap between consumption and production per unit of GDP -- has, on the other hand, remained remarkably constant.  That says to me we should not be so quick to dismiss analogies with the situation in the 1970s.

The headline to Professor Goolsbee's article was "A Country Less Dependent on Oil is Free to Make Other New Year's Resolutions."  I think maybe we shouldn't change that resolution just yet.

UPDATE: Mark J. Perry and Lynne Kiesling found the Times piece more convincing than I did.

January 8, 2007 in Energy | Permalink


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I have to wonder if there is no mistake in your graph on real oil prices regarding the placing of the early nineteen nineties recession (pre- or post-Gulf war, i can't remember). Because, if there isn't, it would look like the recession preceded the short spike in real oil prices, which would be strange. And then, if there was no graphing mistake, that recession would not count in the counting of episodes, which means you'd be left with only two of those. My (vague) memory is that the recession took place right after the Gulf war in 1991, had actually ended by the time of Clinton's brilliant "the economy, stupid", although we had not realised at the time. Thus you should probably move your shaded area slightly, but not before checking with the NBER, which I obviously haven't done.

Another thing that would be inteesting would be to check prior to 1970. There must have been some fairly brutal movements in real oil prices prior to the second world war. Did Milton Friedman look at those in his monetary history?

Posted by: 4degreesnorth | January 09, 2007 at 02:59 AM

The graph is right, although it is worth pointing out that the energy price I am plotting is the retail price of energy generally, not oil. So some of the timing may look a bit different than what you sometimes see. Nonetheless, it is true that recession starts in March 1990 and the Gulf War doesn't really start until at least August, when Iraq invaded Kuwait. And when the US military response commences in January 1991, the recession is over. So the story is not so neat and clean.

Also, the correlation between energy shocks and economic actvity is not so robust to eyeball econometrics before the 73-75 recession. That said, formal analysis by James Hamilton, for example, does support the notion that the oil price shocks matter. The counter case has been made by Ben Bernanke, as I note in one of the posts linked above.

Posted by: Dave Altig | January 09, 2007 at 06:43 AM

Non-monetary inflation can be stopped.

"People today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise." Ludwig von Mises - "Inflation: An Unworkable Fiscal Policy".

All prices do not rise. Only the prices of variable real value non-monetary items while many constant real value non-monetary items are not fully updated and many are not updated at all.

The second inevitable consequence of inflation is the tendency of many constant real value non-monetary items NOT to rise at all - during the Historical Cost era while some constant real value non-monetary items are not fully updated.

Inflation today has and always had a second consequence during the 700 year old Historical Cost era.

Inflation has a monetary consequence, called cash inflation refered to above by Ludwig von Mises and defined as the economic process that results in the destruction of real economic value in depreciating money and depreciating monetary values over time as indicated by the change in the Consumer Price Index.

Inflation´s second consequence is a non-monetary consequence defined as Historical Cost Accounting inflation which is always and everywhere the destruction of real economic value in constant real value non-monetary items not fully or never updated (increased) over time due to the use of the Historical Cost Accounting model or any other accounting model which does not allow the continuous updating (increasing) in constant real value non-monetary items in an economy subject to cash inflation.

Inflation´s second consequence is solely caused by the global stable measuring unit assumption.

The stable measuring unit assumption means that we regard the annual destruction of a portion of the real value of our monetary unit by cash inflation in low inflation economies as of not sufficient importance to update the real values of constant real value non-monetary items in our financial statements.

This results in the destruction of at least $31bn in the real value of Dow companies´ Retained Income balances each and every year. Globally this value probably reaches in excess of $200bn per annum for the real value thus destroyed in all companies´ Retained Income balances.

The International Accounting Standards Board recognizes two economic items:

1) Monetary items: money held and "items to be received or paid in money" – in terms of the IASB definition.

2) Non-monetary items: All items that are not monetary items.

Non-monetary items include variable real value non-monetary items valued, for example, at fair value, market value, present value, net realizable value or recoverable value.

Historical Cost items valued at cost in terms of the stable measuring unit assumption are also included in non-monetary items. This makes these HC items, unfortunately, equal to monetary items in the case of companies´ Retained Income balances and the issued share capital values of companies without well located and well maintained land and/or buildings or without other variable real value non-monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital.

The stable measuring unit assumption thus allows the IASB and the Financial Accounting Standards Board to conveniently side-step the split between variable and constant real value non-monetary items. This is a very costly mistake in low cash inflation economies - or 99.9% of the world economy.

Retained Income is a constant real value non-monetary item, but, it has been in the past and is, for now, valued at Historical Cost which makes it, very logically, subject to the destruction of its real value by cash inflation in low inflation economies - just like in cash.

It is an undeniable fact that the functional currency's internal real value is constantly being destroyed by cash inflation in the case of low inflation economies, but this is considered as of not sufficient importance to adjust the real values of constant real value non-monetary items in the financial statements – the universal stable measuring unit assumption which is the cornerstone of the Historical Cost Accounting model.

The combination of the implementation of the stable measuring unit assumption and low inflation is thus indirectly responsible for the destruction of the real value of Retained Income equal to the annual average value of Retained Income times the average annual rate of inflation. This value is easy to calculate in the case of each and very company in the world with Retained Income for any given period.

Everybody agrees that the destruction of the internal real value of the monetary unit of account is a very important matter and that cash inflation thus destroys the real value of all variable real value non-monetary items when they are not valued at fair value, market value, present value, net realizable value or recoverable value.

But, everybody suddenly agrees, in the same breath, that for the purpose of valuing Retained Income – a constant real value non-monetary item – the change in the real value of money is regarded as of not sufficient importance to update the real value of Retained Income in the financial statements. Everybody suddenly then agrees to destroy hundreds of billions of Dollars in real value in all companies´ Retained Income balances all around the world.

Yes, inflation is very important! All central banks and thousands of economists and commentators spend huge amounts of time on the matter. Thousands of books are available on the matter. Financial newspapers and economics journals devote thousands of columns to the discussion of the fight against inflation.

But, when it comes to constant real value non-monetary items:

No sir, inflation is not important! We happily destroy hundreds of billions of Dollars in Retained Income real value year after year after year.

However, when you are operating in an economy with hyperinflation, then we all agree that, yes sir, you have to update everything in terms of International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies: Variable and constant real value non-monetary items.

But ONLY as long as your annual inflation rate has been 26% for three years in a row adding up to 100% - the rate required for the implementation of IAS 29. Once you are not in hyperinflation anymore (for example, Turkey from 2005 onwards), then, with an annual inflation rate anywhere from 2% to 20% for as many years as you want, you are prohibited from updating constant real value non-monetary items. Then you are forced by the FASB´s US GAAP and the IASB´s International Accounting Standards and International Financial Reporting Standards to destroy their value again – at 2% to 20% per annum - as applicable!

For example:

Shareholder value permanently destroyed by the implementation of the Historical Cost Accounting model in Exxon Mobil’s accounting of their Retained Income during 2005 exceeded $4.7bn for the first time. This compares to the $4.5bn shareholder real value permanently destroyed in 2004 in this manner. (Dec 2005 values).

The application by BP, the global energy and petrochemical company, of the stable measuring unit assumption in the accounting of their Retained Income resulted in the destruction of at least $1.3bn of shareholder value during 2005. (Dec 2005 values).

Royal Dutch Shell Plc, a global group of energy and petrochemical companies, permanently destroyed $2.974 billion of shareholder value during 2005 as a result of their implementation of the stable measuring unit assumption in the valuation of their Retained Income. (Dec 2005 values).

Revoking the stable measuring unit assumption is actually allowed this very moment by IAS 29 but ONLY for companies in hyperinflationary economies. At 26% per annum for three years in a row, yes! At any lower rate, no!

It is prohibited by US GAAP and IASB International Standards for companies that are operating in a low inflation economy.

That means the following at this very moment in time: Today all companies in, most probably, only Zimbabwe (1000% inflation) are allowed to update all their variable real value non-monetary items as well as all their constant real value non-monetary items.

But not the rest of the world.

The rest of the world is forced by current US GAAP and IASB International Standards to destroy their/our Retained Income balances each and every year at the rate of inflation because of the implementation of the stable measuring unit assumption whereby we are all forced to regard the change in the value of the unit of account - our low inflation currencies - as of not sufficient importance to update the real values of constant real value non-monetary items in our financial statements.

We are forced to destroy them year after year at the rate of inflation till they will reach zero real value as in the case of Retained Income and the issued share capital values of all companies with no well located and well maintained land and/or buildings at least equal to the original real value of each contribution of issued share capital.

The 30 Dow companies destroy at least $31bn annually in the real value of their Retained Income balances as a result of the implementation of the stable measuring unit assumption. Every single year.

Retained Income can be paid out to shareholders as dividens. Poor Dow company shareholders. They will never see that $31bn of dividens destroyed each and every year.

We have all been doing this for the last 700 years: from around the year 1300 when the double entry accounting model was perfected in Venice.

When we do this at the rate of 2% inflation ("price stability" as per the European Central Bank and as per Mr Trichet, the president of the ECB) we are forced to destroy 51% of the real value of the Retained Income balances in all companies operating in the European Monetary Union over the next 35 years - when that Retained Income remains in the companies for the 35 years - all else except cash inflation being equal.

Each and every one of those 35 years will be classified as a year of "price stability" by the ECB and Mr Trichet. Mr Trichet will not be the president of the ECB in 35 years time.

I think we will do ourselves a great favour by revoking the stable measuring unit assumption as soon as possible.

FREE DOWNLOAD : You can download the book "RealValueAccounting.Com - The next step in our fundamental model of accounting." on the Social Science Research Network (SSRN) at


Nicolaas J Smith

Posted by: Nicolaas J Smith | January 10, 2007 at 02:44 AM

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