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Thursday, October 22, 2009

Jeff Rubin: $100/barrel oil will return by Memorial Day

Atlantic Gateway concept "reflects yesterday's economy," says oil economist Jeff Rubin. Exclusive full interview with Rubin.

Posted By on Thu, Oct 22, 2009 at 5:26 PM

Oil prices will reach $100/barrel by the end of this winter, and we'll see a return to $1.40/litre ($4/gallon in the US) gasoline prices by Memorial Day, says Jeff Rubin, formerly chief economist with CIBC World Markets and author of Why Your World is About to get a Whole Lot Smaller.

Rubin, who will be speaking to the Halifax Chamber of Commerce November 4, also casts doubt on the logic behind the Atlantic Gateway concept.

In his book, Rubin argues that the defining feature of the world economy is the price of oil. High oil prices caused the American financial meltdown, not the other way around, says Rubin, and high oil prices are sure to return once the recession is over.

As he explains it, the underlying issue is that we have either just reached, or are just about to reach, "peak oil"---the point where total oil production declines, no matter the price for oil. As a result, global trade will necessarily have to diminish, and we'll return to the local economies of the past.

A transcript of my interview with Rubin follows.

Tim Bousquet interviews Jeff Rubin

Bousquet: I think the business community in Halifax may not fully appreciate just how profound your message is. They’re still promoting the notion of Nova Scotia being what they call the “Atlantic Gateway”; basically, they saw that Vancouver and other west coast ports were at capacity, and that trade was still growing, so we could sort of leech off some that trade, particularly Indian and to a lesser degree China trade. We would be a transshipment point for all these goods heading into the America Midwest.

Rubin: Transoceanic trade is going to be one of the frontline casualties, just like North American auto sales, of triple digit oil prices. I don’t think the model of the global economy--- i.e., where you produce something at one end of the world to be sold at the other end of the world, ostensibly to take advantage of cheap labour--- works in a world of $120, $150 oil, because in many cases the savings on labour will be penny-wise and pound-foolish. In other words, you’re going to spend more on bunker fuel than you’re going to save in wages. And that would be true of everything from steel to furniture and especially food. There will some exceptions—textiles and clothing, there’s just too much labour in that and not enough freight cost.

But what’s happened is that countries like China and India, which used to be traditional suppliers of low-wage, high-labour content goods like textiles and clothing, became producers of everything, because everything moved to those countries to take advantage of the wage rates. Well, I think those things are coming back.

The good news for the Maritimes, and indeed for all of North America, is that industries we thought were gone forever may very quickly be coming home.

But, there are several billion dollars in proposed government Gateway projects---twinning highways, putting in new highways, building container transshipment facilities and so forth. And then there’s a private investment of supposedly $3 billion into a new port on the Strait on Canso. Isn’t that a tremendous misallocation of capital?

Well, it could be. But not nearly as huge as the misallocation of capital when the Canadian taxpayer bought 11 percent of GM.

To me, it reflects yesterday’s economy. It’s understandable why that happened, because if you looked at the volume of global trade, it was just growing exponentially, but what you’re noticing this year is for the first year I think in the whole post-war era that global trade is actually shrinking. And I think what we’re going to find when we come out of this recession is that while the pick-up in the economies would seem to stimulate global trade, the attendant pick-up in oil prices is going to nip it in the bud.

So one can understand that sort of Gateway focus based on where the economy has been evolving for the last 20 to 30 years, I guess my point would be to recognize how dependant that global economy was on cheap oil, and how questionable that assumption is going forward.

Some years ago the American financial firm Cisco came to town and sold us on the notion that Halifax could become a world financial centre, literally on the scale of Singapore---we’re an hour and a half flight from New York, we speak English, low wages, highly educated and so forth. And so we have all these plans, we supposedly need two million square feet of office space downtown, and so forth. Is that realistic?

I don’t know—that’s dependant on a whole set of issues other than what I’m talking about, which is the high price of oil. The financial industry is obviously going through a contraction worldwide, and a relocation---the US banking system is going to end up much more Canadian looking when everything is said and done, six, seven, eight, large regional banks instead of thousands of small city banks.

All I can say about the financial issue is this: That while it’s conventional wisdom that this recession was caused by a financial market implosion, I think we’re going to find that that was really a sideshow and that the true cause of this global recession was triple digit oil prices. And if that is indeed the case, then I guess the issue is, in 12 months from now, or sooner, when we see triple digit oil prices again, is the economy going to be able to handle it any better than it was in 2008? It’s not clear to me that the answer is “yes.”

At several points in the book you say the economy will recover, but it seems that oil is the regulator for the economy: once the economy starts going, it pushes the price of oil up, which pulls the rug out from under whatever recovery there is.

I think that’s quite possible. What I said was, particularly in the case of the US, when you force-feed a $14 trillion economy $2 trillion of fiscal stimulus and have interest rates at zero, GDP will respond, at least in the short run. What the long run consequences of that are is something quite different. I mean, GDP will respond simply because of reasons of arithmetic, not macroeconomics. But the point is that when GDP responds---and we’re seeing that already---in the infancy of this recovery, we’re seeing oil prices already at $80. We’ll see them at $100 pretty early, and when we do, are we going to go right back into recession? I would argue the way to avoid that---because at the end of the day we can’t do anything about oil prices getting up to $100---but we can make our economies a lot less vulnerable to triple digit oil prices, and that’s by going back to the model of a local economy.

It takes a lot of time to retool economies.

It takes a lot of time, but you know what? I believe in the power of prices. I think you’re going to see economic behaviour change radically, and change very quickly, when people are confronted with the economic consequences of triple digit oil prices.

Triple digit oil prices can lead to a lot of changes simply because we will no longer be afforded the luxury of being able to live the way we have, and certainly not being able to afford the luxury of having a global economy, because that’s just simply not going to make any economic sense.

In the book, you say, “With transport and logistics costs soon to become even more important, padlocks will be taken off mothballed factories, and machinery that hasn’t run for years will be getting a new greasing.” But a lot of those factories have been scrapped.

Well, you’ll find that those that have been scrapped that they can be rebuilt as quickly as it took for those factories to disappear to China, because even before the recession started, Chinese steel had become high-cost in the North American market because of transport costs.

There’s only an hour and a half labour time in producing a tonne of steel. China has to pay an extra $90 in fuel costs for, first, schlepping iron ore from Brazil to China, and then sending it back.

The same thing with furniture. Most of the Chinese furniture is actually North American wood that has been shipped over. Again, the difference in wage rate isn’t going to offset the difference in shipping costs.

Just as quickly as the market gutted those manufacturing plants in North America, the market will bring them back. And it will be for the very same reason--- it will be because all of a sudden cost curves have shifted, and it will now be cheaper to produce that stuff in North America, at least for the North American market.

We’ve transferred an awful lot of wealth of the continent, so who’s going to be buying all this stuff that the factories are going to be making?

We’re going to go back to serving local markets. The quid pro quo here is that we’re going to be getting a lot of jobs back. Everything that we now produce that used to be produced somewhere else, is going to cost more money. Whether that’s a flat screen TV, whether that’s an ingot of steel, whether that’s the food that you eat---all the economic activity that [because of] high transport costs will be repatriated back home will ultimately cost us more money.

You said $2/litres of gas.

Yes, that’s about the equivalent of $7/gallon in the US.

Is that a prognosis? How do you anticipate this unfolding?

I anticipate us being in triple digit territory for the benchmark crude---West Texas intermediate---by the end of the winter. And I anticipate gasoline prices by the Memorial Day weekend, which is usually the peak of the North American driving season, approaching $4 a gallon, or a buck-thirty, buck-forty a litre prices that we saw in Canada.

Two winters ago we were quite frightened that people wouldn’t be able to afford heating oil for their homes.

We’ll start seeing it in heating oil in the winter. I think that the feedstock here, which is crude, is going to be trading back at $100 a barrel by the end of March, if not sooner.

We’re going to see those prices again, and that’s my general point. If triple digit oil prices isn’t just going to charge another double-dip recession, we have to start changing the way our economy is organized, so the next time that we do see triple digit oil prices, it doesn’t have the same kind of impact.

That process, I think, is going to result in the reemergence of local and regional economies. It’s not that people won’t trade, but our trading partners will be more and more our neighbours, as opposed to markets halfway around the world.

For the tar sands, it looks like you’re pegging oil at $90/barrel for the tar sands to be viable?

Pretty well. And that number will rise over time, as we go into more and more marginal deposits, where the bitumen is deeper and deeper under the ground.

It appeared to me that an awful lot was invested into the tar sands in anticipation of even higher oil prices. So, even when we were at $140, a lot of that investment was chasing prices that were potentially even higher.

I think that’s reasonable.

[But] at $80 or $90, you’re starting to get interest again. You notice what happened when oil fell to $40---companies like Suncor and Imperial Oil were canceling billion and billions of dollars in projects, because they couldn’t raise the capital. Who’s going to invest in a project where your cost of extraction is double the price of oil? Not many.

A lot of workers came home here to the Maritimes.

My prediction is they’ll be going back out.

The Canadian oil sands is really all that’s left. If you look at the US Department of Energy, or the International Energy Agency’s forecast, they have production in the Canadian oil sands growing probably more than anywhere else in the world, from around one to four million barrels [a day]. Yea, that can happen, but it ain’t happening at $70/barrel---that’s going to need prices $150 to $200/barrel to lift that oil out of the ground in an economically attractive way.

A big part of economy here in Halifax is based on tourism---the cruise ship industry has been booming, with this year by far the best year yet. I don’t know how much of that is diverted from people who may have previously gone to Europe…

This basically all relates back to air travel. However problematic the outlook is for General Motors, believe me, it’s even more problematic for the airlines. I think that what’s going to happen in a world of triple digit oil prices is that air travel is going to go back to what it was in the '60s or early '70s, which was essentially a luxury item, not an everyday commodity. The days of flying to Las Vegas for a round of golf with your buddies, that’s over. And so are the days of flying around the world.

So we’re going to go much more regional and local in our vacations. Instead of going on a bike trip through Burgundy or Tuscany, maybe we’ll go to Cape Breton Island. It’s not that people aren’t going to go on vacation; they’re just going to go a lot closer to home.

You make the fascinating point that a carbon tariff or tax is actually a good economic strategy for North America.

That’s right.

But as I was reading that chapter, I was thinking that here in Nova Scotia, about 80 percent of our electricity comes from coal---we’ve got four gigantic coal plants belching carbon dioxide. Any sort of carbon tax or cap and trade system is very much going to hit us hard in terms of producing electricity, and that’s a message that you can kind of work through by turning to renewables and so forth, but it’s not one that the business community here wants to hear.

Well, if we’re going to get a price on carbon, it’s only going to be because President Obama is going to put a price on carbon in his economy, and when he does that, he’s going to be raising the bar for his trading partners, whether they like it or not.

But I would argue that the greatest impact ultimately is not going to be on Nova Scotia power producers---although they’ll have to pay a price for their carbon emissions, but so will Ohio coal plants as well, and it’ll probably be the same price.

I’ll argue that when we do that, we’re only going to do that if we can apply the same rules against the Chinas and Indias of the world, because that’s where the bulk of emissions are coming from. I think we’re going to ultimately charge carbon tariffs.

How does that work?

Let’s say that steel plant in China is powered by coal, because 80 percent of China’s power comes from coal, where it’s about 10 percent in Canada, notwithstanding Nova Scotia and Alberta. So if our steel producers have to pay $40 a tonne, for example, for their emissions in the Canadian or US economy, then we’re going to charge a tariff on Chinese steel, that basically charges the same amount on their carbon emissions that we charge our guys. So if there’s 10 tonnes of emissions embodied in their steel, then we’re going to charge them for 10 tonnes of carbon.

And that’s bullish for North America. In the case of steel, we emit one-third less CO2 than your average Chinese steel plant---so the higher the price on carbon emissions, the greater the economic advantage. The problem now is that carbon emissions are free, so nobody gives a shit. It doesn’t affect the bottom line; it doesn’t effect the price or the profit on Chinese steel.

But all of a sudden, you want the price on emissions to be as high as possible if you’re the lower emitter. And that’s why at the end of the day, you’re going to get Archie Bunker in bed with Al Gore. You’re going to get US Steel to figure out that it’s in their interest to have a higher carbon price.

You suggest that labour is going to embrace a carbon tax.

Yea. In the past, it’s always been that the people who want to raise the environmental bar are typically from the service sector, and are more than willing to sacrifice manufacturing or resource jobs to do that, because all that happens is that the firm goes to China or India where there are no environmental bars.

Here now, we’re reversing it. Instead of sending jobs away, we’re bringing them back home. We’re turning blue collar jobs into green collar jobs, where we have an economic comparative advantage, because 80 percent of the power in North America does not come from coal plants.

I read you book, I listen to your arguments, and it all sounds quite good. You’re for pricing carbon emissions, it’s good for the North American economy. But here I am sitting in Nova Scotia, and I’m thinking that the things we here in Nova Scotia are hoping will help our economy into the future---trade centre, financial centre, tourism---are all going to get pulled down. The guy who has a manufacturing plant in the industrial park in town, he’s going to be paying higher prices because the coal-burning plant he uses for power is going to have a carbon tax… so it may be great for a manufacturer sitting in Ontario, but here in Nova Scotia, there’s really nothing much to benefit from. We don’t even have much in terms of agricultural land. It just seems like a bleak prospect all the way around for us.

Well, on the tourism thing, it’s not clear to me that Nova Scotia will necessarily be a loser---it might be a winner because of tourism diversion; people aren’t going overseas anymore because it’s just too costly to fly.

On the financial, I don’t know. That’s a whole separate set of issues.

On the manufacturing, there’s no reason why Nova Scotia would be any more jeopardized or challenged than some of the US industrial states that have just as high a coal share of power production. They’ll face the same challenges.

I think at the end of the day, it will come down to how quickly people can adapt. As I say, we can’t do anything to prevent oil prices from getting up to triple digit levels, but different jurisdictions will adapt at different levels to that reality, and the sooner we see that coming, the better we’ll be able to handle it, in Nova Scotia, or in Ohio or in Ontario.

You seem much more bullish than the typical peak oil person.

Here’s the thing. Folks who talk about peak oil tend to be apocalyptic. Yea, it can be apocalyptic---it will be apocalyptic if we insist on trying to have the same kind of lifestyle and economy as we did when oil was cheap and abundant.

But I’m an economist, and I believe in the power of prices. I believe that people will radically change their economic behaviour when they see the kinds of prices that I’m talking about.

And in some bizarre ways, the market can lead us to some very green places. I think we’re going to see a lot of the far-flung suburbs in North America re-converted into farmland. I think that carbon emissions are going to have a price and now, for once, we can combine environmental goals with economic goals---i.e., bring back more jobs, make more money, by being cleaner.

So yea, we’re going to have economic sacrifices in the sense that there are things in our past oil-consuming life that we’re not going to be able to afford anymore, but there are also a lot of silver linings in this story that tend to get ignored, because people underestimate our capacity to change.

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