WTI oil futures are trading at over $106 today. This poses significant risks to the economy. The fact that a number of “experts” in the media are going out of their way to tell us that it does not pose a threat should drive the point home.
In “Crude Realities”, Jeremy Siegel tells us not to worry:
“The U.S. consumes about 19 million barrels of oil a day and produces about 9 million b/d, meaning we import about 10 million b/d. Each $10 rise in the price of a barrel of oil increases our import bill by about $100 million a day or about $36 billion a year. In our $15 trillion economy, this increase costs us about 2 tenths of one percent of GDP. If crude rises $20 barrel, as it has from the beginning of the year, this increase will shave about 4 tenths of one percent from GDP. This is hardly debilitating to an economy that is expected to grow between 3% to 4% this year. If the price increase is much larger, say to $200 a barrel, this is more serious and could shave two percentage points from our projected growth. That outcome is likely only if there is a major disruption to the flow of Saudi Arabian oil.”
Seriously? A couple of tenths of a percent off GDP? Has he never heard of the effect of expectations? Has he never heard of the concept of a consumption multiplier? The accelerator effect on investment?
This is the same sort of simple-minded analysis (multiply the percentage of production costs attributed to oil by the price increase and subtract the result from GDP) that led him to declare a few years back that the subprime mortgage problem was “contained” (because subprime was just a small percentage of all mortgages and only a small percentage of subprimes were in default). You’d think he’d have learned his lesson. Apparently not.
The Economist does a little better in declaring that oil prices are “more of a threat than investors seem to think.” Nevertheless, even they go on to underestimate the problem:
“Dearer oil still implies a transfer from oil consumers to oil producers, and since the latter tend to save more it spells a drop in global demand. A rule of thumb is that a 10% increase in the price of oil will cut a quarter of a percentage point off global growth. With the world economy currently growing at 4.5%, that suggests the oil price would need to leap, probably above its 2008 peak of almost $150 a barrel, to fell the recovery. But even a smaller increase would sap growth and raise inflation.”
There seems to be this idea that while the oil price spike of 2008 contributed to the economic downturn, we need not really worry unless the July 2008 peak of $147.50 is breached.
Let’s not forget that the peak number quoted was a one day event, even though the price spike was not.
To put things in context:
- We entered 2008 with oil a little over $95/bbl and exited 2008 with oil just under $45/bbl.
- Oil was only over $100/bbl from late February through late September.
- Oil was only over $120/bbl from mid May through early August.
- Oil was only over $140/bbl for a few days spread out over 3 weeks in late June and early July.
When you think of the oil price spike of 2008, don’t think of $147 oil. Think of oil trading between $100-$125 for six months or so. We’re already in the early stages of the 2011 repeat.
WTI Spot prices from: