2009 September 17 Thursday
Oil Prices To Push Economy Back In Recession?

Steven Kopits says we are in the first Peak Oil recession.

Question: What sort of decline rate to you anticipate, in 2012 or whenever it occurs?

Kopits: I don’t have an independent view on that. The IEA has pointed out that decline rates appear to have increased to 6-7%, and PFC has a very interesting chart on the increase in decline rates from offshore wells over time. By the way, these sorts of developments—secular increases in decline rates, for example—are one reason that I think peak oil is upon us already. Are they proof? No, but they are suggestive. And if you work in the industry, you keep running across similar charts, indicative of a system in trouble even if they are not conclusive. At the same time, you have to keep in mind that there are above-ground constraints on production which could influence aggregate decline rates. You have to consider, for example, whether the Saudis will increase production or if Iraq will get better at administrating its oil industry. There are a lot of things we don’t know at this point that will determine decline rates.

Question: Could you tell us about your views on the US oil price threshold for recessions?

Kopits: The US has experienced six recessions since 1972. At least five of these were associated with oil prices. In every case, when oil consumption in the US reached 4% percent of GDP, the US went into recession. Right now, 4% of GDP is $80 oil. So that’s my current view: If the oil price exceeds $80, then expect the US to fall back into recession.

Then we are within $10 per barrel of another recession. Bummer dudes.

I predict many recessions (or a few really long ones) in the next 15 years. Shrinking oil supplies will be the biggest cause.

Question: In the world of oil analytics, what rules does peak oil break?

Kopits: The primary thing that we have learned—or more precisely, re-learned—in the last year is that the global economy will not tolerate oil at any price. In the first half of last year, we had some prognostications of oil at $150, $200, even $500, and they were understandable because of the supply and demand dynamics at the time. But as we’ve seen since, once our oil consumption exceeds 4% of GDP in the US, we go into recession and we cut our oil consumption. The global economy cannot sustain oil at any price. Beyond a certain threshold, the result is likely to be stagflation or recession rather than perpetually increasing oil prices.

Kopits isn't the only oil industry analyst who thinks oil can't go above $100 per barrel for any length of time. The argument is that high prices will cause economic contraction down to a level that crushes enough demand to lower oil prices back below $100 once again.

But I think this line of thinking misses a fundamental change that high oil prices will cause: In industrialized countries oil consumption will shrink more than overall economic activity and oil's portion of total energy will shrink. As oil becomes a smaller portion of the total energy pie oil's price will be able to go higher without turning into 4% of GDP. Therefore as global oil production declines oil will eventually go above $100 per barrel on a sustained basis.

Economist James Hamilton has done a lot of analysis on the effects of oil price shocks on the US economy and concludes we would not have experienced the current sharp recession without the 2007-2009 oil price shock.

In a follow-up on my earlier post, I'd now like to discuss the second part of my paper, Causes and Consequences of the Oil Shock of 2007-08, which I presented today at a conference at the Brookings Institution. Here I'll review the role that the oil price shock may have played in causing the economic recession that began in 2007:Q4.

My paper uses a number of different models that had been fit to earlier historical episodes to see what they imply about the contribution that the oil shock of 2007-08 might have made to real GDP growth over the last year. The approaches surveyed include Edelstein and Kilian (2007), who examined the detailed response of various components of consumer spending, Blanchard and Gali (2007), who studied the extent to which the contribution of oil shocks has significantly decreased over time, my 2003 paper, which emphasized the role of nonlinearities, and a model-free data summary of the observed behavior of different economic magnitudes following this and previous oil shocks. Although the approaches are quite different, they all support a common conclusion: had there been no increase in oil prices between 2007:Q3 and 2008:Q2, the U.S. economy would not have been in a recession over the period 2007:Q4 through 2008:Q3.

If we experience a double dip recession another spike in oil prices will be the cause.

Share |      By Randall Parker at 2009 September 17 10:29 PM  Economics Energy

Peter North's stunt double (but definitely not gay). said at September 18, 2009 12:25 AM:

Well the Chinese firm of BYD is making great progress in developing effective and competetive Li-on batteries and cars based on them.
Couple this with the Chinese expansion of HTGR type nuclear reactors and the 'problem' is essentially licked.
Of course, the average high IQ and technical prowess of the general Chinee populaion reaps rich dividends.

Stephen said at September 18, 2009 3:28 AM:

More ominous is the price of gold.

...its almost like someone knows something bad is about to happen.

...and its not just the Chinese.

Engineer-Poet said at September 18, 2009 8:30 AM:
In industrialized countries oil consumption will shrink more than overall economic activity and oil's portion of total energy will shrink. As oil becomes a smaller portion of the total energy pie oil's price will be able to go higher without turning into 4% of GDP.
That applies to the world economy, not individual countries; industries and areas which use proportionately more oil will be more affected.  The USA is far more oil-intensive than Europe, so will go into recession sooner and come out later (which seems to be what's happening).

If you didn't already believe that people who demand a "right" to drive guzzling vehicles are objectively anti-American (regardless of what they think they are), that should clinch it.

GW said at September 18, 2009 8:38 AM:

We are going into a long depression, but it doesn't have much to do with oil. It has everything to do with the collapse of one of the biggest credit bubbles in human history. The oil thing is a red herring.

Engineer-Poet said at September 18, 2009 5:47 PM:

What do you think pricked the credit bubble?  We had plenty more suckers to buy condos to flip, but oil ran out first.  AAMOF, oil production had been roughly flat since 2005 and all the credit was just bidding up the price until all the bubbles burst.

Vanilla Thunder said at September 19, 2009 9:37 AM:

"If the oil price exceeds $80, then expect the US to fall back into recession."

Fall back? It's debatable we ever got up out of it to begin with.

GW said at September 19, 2009 3:40 PM:

@Engineer-Poet: The credit bubble halted and then started to implode because it reached the frontier of its maximum expansion, just like all credit bubbles must inevitably do. It had a structural limit to how far it could expand, and we hit it. Optimism and commitment of capital to the creation of more credit maxed out, and the only place to go from there was down. It didn't even take higher oil prices to make that happen. It had already started before the oil bubble got rolling.

matlock said at September 19, 2009 4:19 PM:

Since oil is priced in USD if the value of the US dollar declines substantially against other currencies then the price of oil could rise very high in nominal US dollars (well over $100) but still be cheap and affordable in foreign countries thus causing problems for the US but not those other countries (except to the extent that they rely on the US).

A collapse in the value of the US dollar could signal inflation caused by the Fed going mad with the money supply. In a high-inflation scenario nominal dollar predictions become less valid.

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