Record Crude Oil Prices (Nominally Speaking)

With some headlines blaring about "record oil prices," a bit of perspective is in order. It is true that in nominal dollars, the price of crude oil has never been higher. However, in inflation-adjusted terms, the picture looks somewhat different. It turns out that the price for a barrel of oil peaked at about $98 in December 1979.

Still oil prices have tripled in the past four years, but the economy nevertheless chugs along. Why? A report by Goldman Sachs predicting a possible "super spike" in oil prices last spring sheds some light on that question:

During 1980-1981, gasoline spending in the United States corresponded to an average 4.5 percent of GDP, 7.2 percent of consumer expenditures, and 6.2 percent of personal disposable income, Goldman said.

"Our new $50-$105 per bbl super spike range perhaps conservatively corresponds to gasoline spending in the United States that reaches 3.6 percent of forecasted GDP, 5.3 percent of consumer expenditures, and 5.0 percent of personal disposable income.

Goldman said that were it to assume gasoline spending needed to reach 1970s levels to destroy demand, its upside super-spike estimate would be $135 per barrel for New York crude.

"Perhaps the ultimate answer to high how oil prices need to go before demand destruction occurs is derived from knowing when American consumers will stop buying gas guzzling sport utility vehicles and instead seek fuel efficient alternatives.

"Based on our analysis of gasoline spending and the economy noted above, we estimate that U.S. gasoline prices may need to exceed $4 per gallon."

In other words, the price of oil would need to double from today's $70 per barrel to have the same impact on the U.S. and world economy that prices had during the 1970s oil crisis. This could happen because neither the oil majors nor state-owned companies invested much in boosting oil production or discovery when oil prices were so low in the 1990s. At the time there was also excess production capacity of 10 million barrels per day. Excess production capacity is down to 1 to 2 million barrels per day, so any disruption can cause a shortfall in supply, and since demand for petroleum is relatively inelastic in the short run, a rapid run up in prices.

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  • ||

    Isn't using %GDP a little problematic, given the state of the economy in 1980-81?

  • ||

    Not sure why that would be a problem. Based on the GDP #'s, for example, defense spending has essentially been at a steady state since WW2.

    Of course, if the GDP is problematic for that calculation, it actually means we've been under-spending on national defense since WW2.

  • Garth||

    Given our fiscal and current account deficits one could postulate that the dollar is at risk of a serious adjustment. Given that oil is a global commodity a repricing of the dollar (depreciation) would have an immediate impact of a rise in the dollar price of oil. It could very well be that if and when the dollar gets smacked we will see dollar oil prices soar independently of gloabl demand or supply.

    (Of course our demand would likely start falling on such a move in spite of its inelasticity)

  • ||

    Part of the inelacticity of demand is due to our effiency. The U.S. produces much more GDP per barrell of oil now than in the 70s. We gripe about gas guzzling SUVs getting 18 mpg, hell that was good milage for the typical family car in the early 1970s.

    The market will work as it always does. The higher prices have already started an oil shale boom in Canada and could do the same in the Western U.S. if you could get it past the gia worshipers. People will drive less and demand at some point will start to go down and supply will increase through increased exploration.

  • ||

    rob,

    %GDP is a very useful figure, especially over time. We can see the treands in military spending as a % of GDP and draw meaningful conclusions.

    It's the use of one year's figure that's problematic in this case, because it's impossible to tell to what degree the figures for the 80-81 time period reflect a lowered GDP, vs. higher gas costs.

  • Warren||

    Driving up the price of oil has been the primary aim of this administration.

  • ||

    I have a problem with tieing the entire ecnomic out put of the nation (GDP) with prices in a single industry (Oil).

    After all the economic landscape is quite different today with different types of companies operating in the economic theatre.

    The rise is price of oil probably has more to do with news in the middle east than anything else. The headlines urgency (exaggerated yes, but not outright fabricated) is perhaps a reference to the fact that we seem to be on a showdown in Iran.

    And anyone who reads between the lines will surely recognize that the drums of war are quite prmeditated. AIPAC ran giant TV screen rotated ads in their last two conventions about how "we must confront the Iranian threat now". So the world knows that US is itching to go into Iran and a catastrophic turning point (or event) will materialize soon to tip the reluctant US public into supporting the "Operation Iranian Freedom" (It's early morning that's the best I could do).

    So knowing that a war is coming and the world's 4th largest Oil producer is the target. The prices of oil have jumped up.

    Whether the headline accurately reflects the absolute highest price of the oil ever or not, is truly a non-issue if you look at the bigger picture geopolitically not just economically.

  • ||

    "Of course, if the GDP is problematic for that calculation, it actually means we've been under-spending on national defense since WW2."

    Spot the logical fallacy(ies).

    Now, as to the usefulness of GDP as a number, joe points out one problem. I won't even get into the fundamental problem (value is subjective), but I'll just point out another biggy:

    In the '90s, the Clinton administration changed the way CPI was calculated, in order to decrease social security payments. If we still used the old CPI measurement, inflation numbers would be equivalent to those in the late 70s! So, when relying on "inflation adjusted" numbers, like GDP, make sure you look at how it is adjusted. If using the current calculation of CPI, you're going to get an artificially high number for current GDP in inflation adjusted numbers - and the difference is big.

  • ||

    All the information you'd ever likely want about calculating the consumer price index here. Just follow the links there to whatever you think relevant.

  • Captain Holly||

    The higher prices have already started an oil shale boom in Canada and could do the same in the Western U.S. if you could get it past the gia worshipers.

    Have no fear of the Granolas, John. The West is in an oil and gas boom right now. In fact, some obscure company found a big field in central Utah that -- if all predictions are correct -- could yield billions of barrels of oil.

    Now if some company would start building refineries to process it....

  • ||

    I hope you are right Captain Holly.

  • Captain Holly||

    I hope you are right Captain Holly.

    Here's the most recent article I could find about it:

    http://deseretnews.com/dn/view/0,1249,635180904,00.html

    BTW, we don't have a crude oil shortage per se. We have a refining shortage, which contributes to our yearly price spikes by creating bottlenecks and restricting supply.

  • ||

    Holly,
    I don't see any indication of how much that new oil would cost to drill and purify. Any indications?

  • Thomas Paine's Goiter||

    Now if some company would start building refineries to process it....

    There are a boatload of companies willing to build refineries. There are no states that will let them.

  • Captain Holly||

    I don't see any indication of how much that new oil would cost to drill and purify. Any indications?

    Don't know, either. But I can say that although Utah has plenty of oil, it's "expensive" oil, ie, it's either hard to get out (oil shale) or hard to refine (icky black stuff).

    The fact that so many companies are willing to drill in Utah now is prima facie evidence that given current prices, it's finally profitable to market Utah oil.

  • ||

    joe,
    That's why I should have RTFA, I guess. My understanding from skimming it was that it was an analysis over time not just "one year's figure" which I would agree is "problematic in this case."

    But Ron's link is pretty cool!
    http://inflationdata.com/Inflation/Consumer_Price_Index/CPI.asp

  • Thomas Paine's Goiter||

    I don't see any indication of how much that new oil would cost to drill and purify. Any indications?

    From all of the research I've done (and it's significant), the Tar Sands were breakeven when oil stabilized above $35 bbl. They'd be much cheaper if Canada were to bring a nuclear plant online.

    The Shale Oil SHOULD be breakeven when oil stabilizes at $55.

  • ||

    Captain Holly,

    I am told that the oil sands of Alberta are profitable as long as oil stays above $40 a barrell. It costs something like $25 dollars a barrell plus the initial investment to refine the sands versus like $2 for sweet crude in the Persian Gulf. As long as oil stays above $40 a barrell, a pretty good bet, the boom will be on.

  • ||

    Captain Holly, how is a refinery shortage supposed to account for an increase in the price of crude oil? That's like saying that a shortage of ovens is making flour more expensive. A refinery shortage would press the price of oil down. If it's going up anyway, it's because of something else.

  • Captain Holly||

    Captain Holly, how is a refinery shortage supposed to account for an increase in the price of crude oil? That's like saying that a shortage of ovens is making flour more expensive. A refinery shortage would press the price of oil down. If it's going up anyway, it's because of something else.

    Just a note: When I said "yearly price spikes", I meant the price of gasoline, not the price of crude oil.

    The price of crude is set mostly by worldwide demand. But in the US, we have yearly spikes in the price of gasoline and diesel that can be exacerbated (as we saw last year) by the fact that there hasn't been a new refinery built in the US since the early 80's.

    Refineries in the US are running at near 100% capacity. There's no excess capacity in the system to absorb any interruption in supplies (natural disasters) or increases in demand (summer driving season) or changes in production (EPA Clean Air mandates).

    Hence, a bottleneck in supply, which leads to higher prices.

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