High Oil Prices: Why $200 Oil Won’t Cause A Recession (USO, XLE, UGA, COP, XOM, CVX, DVN)
Martin Hutchinson: Last Friday’s weak unemployment numbers, with only 120,000 jobs created, brought renewed wails that high oil prices were causing a recession. Having heard this refrain so many times, I thought I’d dig a little deeper.
After all, a peak of $145 per barrel in the West Texas Intermediate oil price pretty well coincided with the onset of the 2008 recession.
The question is whether or not high oil prices are always correlated with an inevitable downturn.
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For instance, when you look closer, oil was not to blame in 2008. Other factors were much more serious culprits, including the housing crisis (by then in market collapse) and the banking crisis that followed.
Between them they are the hallmarks of financial crisis that brought on the nasty recession.
To find out why, we need to do a little arithmetic.
High Oil Prices and the Economy
The U.S. Bureau of Labor Statistics breaks down personal consumption expenditures (PCEs) on energy versus other items on a month-by-month basis.
The PCE on energy goods (which include natural gas and electricity) rose from 5.05% of total PCE in 2004 to 5.88% in 2007 and 6.31% in 2008. When oil prices peaked in July 2008 PCE hit a maximum monthly level of 7.01%.
Thus taking the increase from 2007 to the highest month in 2008, energy PCE rose by 1.13 % of total PCE, or about $115 billion on an annualized basis.
That sounds like a lot of money, but it’s well under 1% of GDP.
For example, it’s less than the estimated $152 billion cost of former President Bush’s ineffective 2008 tax rebate stimulus.
Indeed, it is one-seventh the size of President Obama’s stimulus the following year, which didn’t have much visible effect. Thus the high oil prices of 2008 might have made the difference between marginal growth and marginal decline, which according to the “butterfly effect” of chaos theory could have caused other larger changes.
However, high oil prices were certainly not sufficient to push an otherwise healthy economy into recession.
2007 vs. 2012: Comparing High Oil Prices
This time, oil prices are rising from a higher base.
The average West Texas Intermediate oil price of $94.87 in 2011 was 31% above 2007′s average. It follows that an oil price jump to $147 would not be very economically significant.
In this case, we would need a larger spike to have any noticeable effect.
Oil prices did spike 101% from 2007′s average to the peak on July 3, 2008. A similar rise from 2011′s average would take the price of oil to $191 per barrel.
If that jump raised energy PCE by the same proportion as in 2008 (starting from 2011′s higher energy PCE of 6.07% of total PCE), it would push it up to 7.24% of PCE. This equates to a rise of about $129 billion.
If oil touched $200 a barrel, the rise in personal energy expenditures might be around $140 billion.
Again, at 0.9% of today’s GDP that increase is just not big enough to cause recession in an economy growing even moderately.
It’s just a little larger than the $118 billion “stimulus” from continuing the payroll tax cut for 2012.
It would slow growth, but given that we are currently experiencing growth of around 2%, it would not turn our current growth into decline.
With Federal Reserve Chairman Ben Bernanke’s zero-interest-rate policies in place until 2014, and the chance of yet more “stimulus,” it is indeed possible we will see oil at $200 per barrel.
The price could get there gradually, over the next 12-18 months, or it could leap there in one bound, if Iran closed the Straits of Hormuz. That would be very unpleasant, pushing gas prices up to $7 per gallon.
But the above calculation shows that on its own $200 oil would not push the U.S. economy into recession.
Indeed, we should not expect it to; Europe has suffered from gas prices of $8 to $10 a gallon for several years now. While the European economy has many problems, it seems to survive its gas prices.
So we should expect to pay more for gas, but on balance should not expect recession from doing so.
As in 2008, the next recession is much more likely to be caused by the banking system!
Related: United States Oil Fund (NYSEARCA:USO), SPDR Select Sector Fund (NYSEARCA:XLE), ConocoPhillips (NYSE:COP), Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX), Devon Energy Corporation (NYSE:DVN), United States Gasoline Fund LP (NYSEARCA:UGA).
Written By Martin Hutchinson From Money Morning
Martin is a Contributing Editor to both the Money Map Report and Money Morning. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. At Creditanstalt-Bankverein, Hutchinson was a Senior Vice President in charge of the institution’s derivative operations, one of the most challenging units to run. He also served as a director of Gestion Integral de Negocios, a Spanish private-equity firm, and as an advisor to the Korean conglomerate, Sunkyong Corp. In February 2000, as part of the Financial Services Volunteer Corps, Hutchinson became an advisor to the Republic of Macedonia, working directly with Minister of Finance Nikola Gruevski (now that country’s Prime Minister). The nation had been staggered by the breakup of Yugoslavia – in which 800,000 Macedonians lost their life savings – and then the Kosovo War. Under Hutchinson’s guidance, the country issued 12-year bonds, and created a market for the bonds to trade. The bottom line: Macedonians were able to sell their bonds for cash, and many recouped more than three-quarters of what they’d lost – to the tune of about $1 billion. Hutchinson earned his undergraduate degree in mathematics from Cambridge University, and an MBA from Harvard University. He lives near Washington, D.C.
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Why in the world would anyone listen to a derivative trader who stands to make money every time oil prices surge. This gentleman, and I use this term very loosely, has no problem sucking the life out of consumers both here and around the world.
What utter nonsense.
To what height by Mr Hutchinson’s logic would oil have to climb to before it would cause a recession?
2011 US GDP : 15 trillion (give or take)
Q4 2011 growth rate (allegedly) : 3.0%
Annulised nominal growth amount: 450 Billion
So if the only figure that matters is the affect of oil on PCE energy, and if WTI going from $102 too $200 reduces GDP by 140 billion, how high does it have to go?
$417 a barrel oil just to drag the US to 0% growth!
Ridiculous
I don’t agree. Rising gas and food prices are outstripping wages and stretching many budgets to the breaking point. Also, people are reminded of these rises constantly. All together, the psychological effect is severe and leads to tightening of household budgets even if these rises are affordable.
Keep in mind incomes have been declining for years, making even marginal increases in personal energy expenditures more significant. The consumer is battered and less able to absorb energy expenditure shocks. Other studies have said $5.50 gas is where you really see people begin to adjust their behavior which we would get well before oil hit $200.
You say,”…taking the increase from 2007 to the highest month in 2008, energy PCE rose by 1.13 %.
I say, not so. An increase,from 5.88% to 7.01%, is approx. 19%.
Your figure represents an increase in % POINTS!
Needless to say, 19% would be a killer.
I have to disagree with this article, which is pretty much nonesense. I predict that the U.S. economy will be in recession by the end of the year if oil follows annual trends this year. For a far better analysis of oil prices and recessions, I suggest you leave this silly article immediately and move to Gail Tverberg’s excellent blog post on this topic, in which she begins by stating:
We know high oil prices have an adverse impact on the economy, often leading to recession. According to Economist James Hamilton, 10 out of 11 of US recessions since World War II have been associated with oil price spikes. But where do continuing high oil prices lead us? How will economic contraction “play out,” if tight oil supply and high oil prices continue?
Her full blog can be read at: http://ourfiniteworld.com/2012/01/18/where-do-continued-high-oil-prices-lead-us/
I agree with Mark.
Like Mark R., I also have to disagree.
PCE on energy may only be a bit over 5%, but oil plays into the economy in a number of ways; feedstocks for plastics, other industy, drugs, etc, also agriculure; not to mention transportation costs for everything..
I have to disagree with your assessment of the effects of $200 oil. Let’s use your $140 billion for the cost increase to GDP, it’s a good estimate. The problem is that it falls entirely on consumers. I did the best I could, and came up with an estimate of $6.9 trillion for total household income. Estimate 30% for all taxes, and consumers are left with $4.8 trillion to spend. The $140 billion increase in fuel costs translates into 2.9% of available household income! This is more than enough to cause a major shift in consumer spending, and therefore GDP.
I live in the Western US. Comparing us to Europe is a case of apples and watermelons when it comes to fuel prices. Europe is much smaller and has much greater population density, allowing for mass public transportation and many fewer miles driven per person. They therefore require higher taxes per gallon to maintain their system, since consumption per person is so much lower. It is also a rationing system to keep vehicle numbers manageable. People here travel much more, for work, general living,and recreation. I spent $10,000 on vehicle fuel last year, less than $2000 on food, only $7000 on housing. Doubling my fuel bill and increasing transportation cost for the things I buy would more than eliminate any discretionary income I have. The only way to survive would be to lower my standard of living. Is that the goal? To lower the USA standard of living to the rest of the world? $200 oil would go a long way to making that happen.