US Competitiveness in a Tight Oil Era

Value of goods and services produced per barrel of oil in various countries, 1980-2008. Comparisons are done at purchasing power parity, and corrected for inflation to 2005 dollars. Sources: IMF World Economic Outlook for GDP data, BEA table 1.1.4 for deflator, and BP for oil consumption data.

I argued last week that oil supply for the last five years appears to be in a regime were it responds only weakly to changes in the oil price, and that 2009 data very much fit the same pattern.  I called this the era of inelastic oil.  I then pointed out that assuming this continues, it's likely that developed countries, and the US in particular, will have to conserve extensively because oil usage in developing countries, particularly rapidly industrializing Asia, will very likely continue to increase.

Since resources and workers in the US and Europe are currently underutilized, a recovery even to full utilization (eg normal vacancy rates and unemployment rate) will require additional oil.  Since it's not likely that very much additional oil will be available at a reasonable price, the only way for the developed countries to recover is to get more oil efficient. Therefore, in this piece I look at trends in oil efficiency, both across time and comparing the US to leading economic competitors.

Firstly the headline graph, repeated below, shows the ratio of goods and services produced, per barrel or oil, for a variety of countries, over the last thirty years or so.

Of course, it takes a lot more than oil to make the goods and services - other forms of energy are included, as are various forms of matter (iron, aluminum, etc).  Finally, most of the cost of the goods and services currently goes on various forms of payment to humans - wages, profit, etc.  However, oil is pretty essential to the production of most goods and services, and just about all of them in the United States which is completely dependent on oil for mobility.  And so it's of interest to know who uses how much oil to produce a dollar of goods and services.

Value of goods and services produced per barrel of oil in various countries, 1980-2008. Comparisons are done at purchasing power parity, and corrected for inflation to 2005 dollars. Sources: IMF World Economic Outlook for GDP data, BEA table 1.1.4 for deflator, and BP for oil consumption data.

As you can see, the US (black line) compares unfavorably with most major economic competitor nations. The UK (financial services) produces nearly twice as much GDP with a barrel of oil as the US. Other big European countries - France (wine), Germany (cars) - are not far behind. China (consumer goods) and India (software) are both of tens of percent better than the US, and both are improving faster too.

This is good news if you are British, German, Chinese or Indian.  It's not such good news for Americans.  The issue is this: in a bidding war for oil, who can bid more for a barrel - the folks who can turn it into $2500 or $3000 of goods and services, or the Americans who can only make it into $1800 of goods and services?

Clearly, this oil-inefficiency puts the US at a disadvantage if oil is in an era of inelastic supply, such that prices are going to be high and volatile.

If you want to feel really bad about it, look at it this way: the famously inefficient Russian economy now produces more goods and services with a barrel of oil than we do.

On the positive side, most economies have gotten markedly more oil efficient in recent decades.  This next graph explores that for the last ten years.  I've plotted the average annual improvement in GDP/barrel for a variety of countries of interest.

The red line on the graph is at 4%.  Last week, I showed that if global oil supply was flat, and if the developing regions of the world continue to grow at the rate of the last five years, then developed country oil consumption would have to decline at 4% per year.  In that particular hypothetical future, oil efficiency would have to increase at 4% a year in order to avoid the OECD economies continuing to shrink.

If you thought oil production would grow sluggishly, then the red line would be further to the left, and if you thought it was going to decline, then it would be further to the right.  And of course, most people would like to see OECD economies grow, rather than stagnate.  That would imply, in my best-guess scenario of roughly flat oil production over the next five years, needing to improve oil efficiency at better than 4% per year.

As you can see, over the last ten years, a few countries, eg Sweden and South Korea, are demonstrating that this is possible.  Other countries, the United States in particular, have to make progress significantly faster.

Let's drill down in detail into factors that affect US oil efficiency, at least for the road transport sector, which accounts for a little over half of US oil usage.  Let's first break this down into a product of two factors - the fuel efficiency of vehicles, and how well we create goods and services per unit of moving around - here measured by vehicle-miles-traveled data from the Federal Highway Administration.  I posted this graph last week:

US economic output (GDP in chained 2005 dollars) per vehicle mile traveled 1960-2008. Source: FHWA for VMT data, BEA for GDP. 

Note a couple of things - historically, this ratio is pretty constant.  In particular, note that it doesn't respond to oil shocks - in 1974, 1979, and 1991, you don't see the ratio jumping up much as people respond to sudden increases in the price of oil by cutting back on frivolous, uneconomic driving (a point I'll expand on in a future post).  Secondly though, we do see this ratio improving from the mid 1990s on, with a short setback in 2001-2002.  This pattern strongly suggests to me that the improvement is due to the deployment of the Internet.  If you recall, serious commercial use of the Internet began around 1994-1995.  The Netscape IPO - the first Internet related public stock offering - was in 1996.  That's when that rise in this ratio started.  And the setback to Internet business following the bursting of the tech bubble in 2001-2002 shows up in this graph, as does subsequent resumption of growth in the adoption and usage of the Internet.

Proving this, and figuring out exactly how it would work in detail, which is a bit mysterious, will have to await future posts; for now it is just a strong working hypothesis.  At any rate, the improvement in this ratio has been at an average rate of 1.5% a year over the decade 1998-2008.  That of course has directly contributed to improving the oil efficiency of the US economy (and of course likely other countries too).

But one thing we don't see, is much acceleration of this trend in 2005-2007 with the big oil price rise.  That's unfortunate - it would be nice if we could raise our game in times of high oil prices, but so far we didn't in this respect.

We also didn't in respect of fuel economy.  This next graph shows the trend in US deployed fleet fuel economy for light vehicles.  Note this is not the average fuel economy of new cars at purchase time.  Instead, this is taking all of the vehicle miles driven by light vehicles and dividing them by the amount of gasoline sold (full methodological detail is at this old Oil Drum post of mine - see also here).

Estimate of US deployed gasoline fuel economy by month, Jan 1990-July 2009, with 12 month trailing average and linear trend. Graph is not zero-scaled. Click to enlarge. Source: FHWA for VMT stats, EIA for gasoline supplied, and Transportation Energy Data Book for diesel vehicle correction.

Overall, this series has showed an average 0.52% annual improvement over the last ten years.  Combining the mobility productivity and the fuel efficiency improvement, we get an overall improving of about 2.1%, pretty close to the ten year average improvement rate in GDP/barrel for the US, which was 2.3%.  The interpretation of this fact is that productivity improvements in road transport oil efficiency roughly match those in the utilization of oil in non-road usages.

Once again in fuel economy, we see that improvements are not happening as fast as it seems like we will need going forward, and in particular, the graph above does not show any improvement in the 2005-2009 timeframe - it kept pretty much to the long established trend.

In short, the 2005-2008 oil price shock caused no discernible improvement in the long-term trend of gradually increasing oil efficiency.  This is discouraging - people clearly did not get the message.

If you look back at the comparable data for the 1970s (from here):

Estimated fuel efficiency for all deployed gasoline vehicles in the United States by year, 1945-2005. Click to enlarge. Source: Author's approximate calculations based on FHWA Highway Statistics series for vehicle miles traveled data, and US EIA for data on finished motor gasoline supplied. See here for details.

What you find is that in the period 1973-1978 (blue in this graph), after the first oil shock but before the second, there was also limited fuel efficiency improvement.  It was only after the second shock in 1979-1980 that people got serious about making the auto fleet more efficient (red region is 1978-1992).  Maybe, now, we are also waiting for that second shock in order to get serious again.