The Costs That Don't Count - Energy and Food

There is an interesting article in the October 23rd NY Times - If You Don't Eat or Drive, Inflation's No Problem. Daniel Gross points out that energy costs and food are not in the calculation for the "Core" inflation rate calculations - the figure given as the "inflation rate." These two items are consider "headline" inflation rate, meaning they are too "volatile" to include in the calculations These two "volatile" items were removed from the calculation after the 1973 oil embargo. For peak oilers, that should send up flags.

The pocketbook relationship of energy costs and food for the average person certainly calculate into how far one's paycheck goes. For example, gas prices have increased roughly 35% over last year, which was on top of roughly a 30% increase the previous year. Energy prices in general have been climbing steadily. Natural gas rates were already almost 50% above last year's rate before the increases due to the "disruption" of the hurricanes in the Gulf of Mexico. Leaving food and energy costs out of the official inflation rate, we have a 4.7% increase so far this year.

Unfortunately, we live in an oil-based economy. As the cost of oil steadily increases, the cost of virtually everything increases with it. As we are learning to our chagrin, oil and food prices are not independent of each other either. As the costs of energy and food leap up the real value of our pay goes down. It is going to go down much further.

In a recent presentation, Matthew Simmons (labeled as an "oil guru" by Reuters), predicted that oil could go to $190 a barrel. Simmons argues that: demand is getting too close to supply; too much of the destruction caused by Katrina and Rita has not come back on line; and that there is a real possibility of a shortage of both oil and natural gas. This combination could easily double or triple current prices. This would potentially send oil for $125 - $190 a barrel, and natural gas form $13 per million BTU to $40 per million BTU.

There are two presentations available from Simmons' site that are instructive: An Energy Tsunami Ahead (10/19/05) and Today's Energy Reality: We Are In a Deep Hole (10/18/05). He highlights the things that anyone who has done reading in the area of energy resources already knows. Namely that demand is growing much faster than supply; energy reserves have been wildly exaggerated, and that there doesn't appear to be much left in the discovery bag of tricks. However, the energy crunch (and potential shortages) in the U.S. this year have much larger ramifications. In the Energy Tsunami presentation he notes that "95% of the world now beginning to use modern energy." That "modern" energy is oil, gas, and nuclear based. Effectively, that means that 95% of the world is competing with each other for these energy resources.

A shortage in the U.S. also means a shortage in the global energy market. Britain, for example looks ready to run short on natural gas this year. This is big news as much of the electricity is natural gas generated, and so is much of the heating supply. Britain's "plan" is to shut down business and industry first in the event of a crisis. That means that two of the significant global economies (the U.S. and Britain) could be in for major disruption this winter. The dominoes are balancing on their edges here.

Back to energy and food and the cost of living. Increasing energy costs will drive up "core" inflation. As expense continue to rise, the costs of goods and services will go with them. People will be facing no-win choices between necessities and transportation, and even more critically, between heating their living space and having a living space. The government may massage the numbers as if energy costs are somehow separate from other economic indicators, but in an oil-based economy the truth will tell. As basic costs go up, people will buy less. If people buy less, then it is not inflation but recession that becomes the driving issue.

The problem is that the "crisis" may moderate with warmer spring temperatures, but the damage will already be done. Economic recoveries do not happen over night. History indicates that once the price of oil goes up it is unlikely to come back down to pre-crisis levels. Oil and gas prices will stay high, perhaps lower than at whatever peak they hit this winter, but high from today's price.

The United State's recovery from the last recession - purportedly caused by the crash of the "dot coms" - was consistently referred to as a "jobless recovery." For most of us that meant that somebody was "recovering" but it was not us. It will be interesting to see what will happen with the next "recovery," and whether it will be more participative. However, it is much more positive to not look at what is happening to people and has the numbers - whether that is what counts as inflation or what counts as recovery.