Record Crude Oil Prices (Nominally Speaking)

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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.