The Peak Oil Crisis: Oil & a Government Default

October 2, 2013 6:16 PM2 comments

It was only a month ago that we were worried that a U.S. strike on Syria in retaliation for the poison gas attacks would trigger a wider war in the Middle East sending gasoline prices spiraling. In the last two weeks however, and much to everybody’s surprise, an era of good feeling broke out in the Middle East wiping out much of the $20 a barrel “geopolitical risk premium” in the price of oil and sending prices down by nearly $10 dollars a barrel and gasoline futures down by some 35 cents a gallon.

Events move quickly these days so that we hardly had time to fill our gas tanks with the cheaper gas when a new, and potentially more serious, crisis emerged this time right here in Washington. The federal shutdown is currently in full swing and for now the rhetoric suggests it could be a prolonged crisis. For those with a short memory, the last shutdown, or slowdown as those who think it is a good idea prefer to call it, took place back in 1995-96 and lasted about three weeks. But things could be different this time.

The ideological chasm between left and right in the country has widened and hardened considerably in the 17 years since Newt Gingrich was in control of the House and Bill Clinton was in the White House. The economy is in much worse shape, oil prices are five times higher, and most importantly, there is a debt ceiling crisis only two weeks away that could result in a default of the U.S. debt and resulting financial turmoil.

The impact of the federal shutdown will depend mainly on how long it lasts and how dependent you and your locality are on federal spending. The Washington region, where about a third of the economy stems from federal spending, will be among those hit the hardest. Some $200 million a day in federal payments will not be taken home during the shutdown so that all those whose income depends on federal appropriations, estimated to be about 700,000 people, will be hurt. Beyond the loss of federal salaries are losses from reduced tourism and many other federally supported activities. As anybody ever subjected to Economics 101 can appreciate, the loss of federal spending will quickly be felt across the economy as non-essential retail sales will plummet as suddenly impoverished people cut spending to essentials.

Great pains, however, are being taken to see that real economy-killing services such as halting commercial air travel, or social security and other vital payments will not happen, at least immediately. However, most observers agree that a prolonged shutdown would do considerable economic damage.

So what happens to oil and more importantly to gasoline prices during a shutdown – either brief or extended? The short answer is that unless some outside development such as a major blowup in the Middle East occurs, oil and gasoline prices are likely to fall as there will be less money to spend, less economic activity, and less gas and oil being bought. At a minimum all those furloughed workers will not have to drive to work and will probably be watching their pennies till the situation clarifies. If nothing else, the equity markets, which have already started to fall, will likely pull oil prices down with them.

It is important to keep in mind that America is no longer the preponderance of the global oil market and that a slowdown of government spending in the U.S. has little effect on demand in most other places that will continue to maintain or increase their oil consumption. With OPEC, particularly Iran, Nigeria, and Libya, producing well below their normal rate, the world oil markets are tighter than normal so there is definitely a floor under oil prices. It is unlikely that they will plunge back to the good old days with all the turmoil in the Middle East.

A far worse problem, however, a possible default on the federal debt, will be in the fore about two weeks from now. If the shutdown is still going on when October 17 rolls around the situation could easily become extremely serious.

For numerous reasons a default on the U.S. debt would be far worse than anything we will see even with a prolonged federal shutdown. For this reason many believe that a default will never happen as those in Congress relishing or at least acquiescing in the shutdown will come to their senses and stop the debacle. The Editorial Board of the Washington Post is not as complacent as many about the possibility of a default. They note that the “habits of normal compromise have become so frayed” in Washington that it is equally plausible that the forces shutting down the government will add default to their handiwork.

The problems that would come from a failure to raise the debt ceiling on October 17 are legion. Federal spending would be cut by about a third. There would be delays in the issuance of many federal payments. Interest rates would increase markedly despite the best efforts of the Federal Reserve. The dollar would be certain to fall substantially in relation to other currencies driving oil prices higher. There would likely be a world-wide financial crisis reminiscent of 2008 or worse.

Some are already suggesting that we would likely see oil prices above $120 or $130 a barrel as a consequence of a 10 percent or more decline in the value of the dollar and the nationwide average price of gasoline would rise to well above $4. Five dollar gasoline is not out of the question if the debt crisis continues or the dollar continues falling. Such prices would do considerable economic damage as discretionary driving would fall markedly and along with it much retail spending on goods and services. Further economic growth under such a scenario would be problematic.

The peak oil story started out about 15 years ago focused on the rate at which the world’s oil fields were depleting and indeed this remains a critical part of the story. In the intervening years, however, it has become apparent that there are other factors that can determine when oil becomes too scarce or expensive to continue being used in the current manner and a default on the U.S. debt might just be one of them.

  • Gregory Wade

    Fiscal and Monetary policy are creating more economic harm.

  • stopthesocialism

    Printing trillions of new dollars is hardly “coming to your senses”. Only in the bizarro world of the left wing loonies.

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