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High Oil Prices: Even $200 Oil Won't Cause a Recession

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.

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!

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Join the conversation. Click here to jump to comments…

  1. Urani Diot | April 12, 2012

    You are mind-numbingly ignorant.

    • Steve | April 12, 2012

      I believe Martin is viewing the world as one who will suffer a less than 1% loss of discretionary income allocated to necessities derived from oil. That is a different perspective than one who must either borrow or simply do without to balance income with expenses. You see, those who imbibe with the market regard the subsistence economy (the 99%) as irrelevant to their concerns.

  2. Graham | April 12, 2012

    I concur with your analysis. As a petrol head, mechanic (admitidly earthmoving) and now an engineer in the oil and gas industry I have had a long term interest in observing the effects of energy costs. I have also lived in both the UK and Australia (although not the US) and it is clear that while people aim to do much the same thing in modern economies they adjust their behaviour depending on the long term cost of energy. So in the UK where petrol prices are significantly higher than Australia the average car size is much smaller, you see far fewer of the large 4-wheel drives (SUV's) that are common in Australia. Also, most houses in the UK are smaller and better insulated than in Australia and therefore have much lower heating / cooling costs than the typical Australian house which lacks double glazing has high loss window frames and often inappropriate designs for the climate.

  3. Joan Carleton | April 12, 2012

    Which sector are you trying to make feel good with this article?? Do you ever watch the Dow Jones Transportation Index? Seven dollars a gallon gas at the pump will definitely affect our economy. I won't waste my time writing the many counter arguments to the above crapola.

  4. brian taxman | April 12, 2012

    I appreciate your analysis. However, in N GA we do a bit more driving than your average, but I won't quibble about that. The point I would like to make is that I assume everyone pretty much spends all that they make. So if I am paying an additional $100 a month for gas, it means that I am not buying something else. It also means that the gasoline money is leaving the country and not being spent in the USA. Hard to imagine that not affecting the economy in a negative fashion.

  5. Mary W | April 12, 2012

    This article is beyond out of touch. I have to agree with the preceding reply, it is mind numbingly ingnorant. Most working people live on a budget. They must drive to work and the grocery store. The kids still have to go to school and ball practice. The restaurants have to buy propane. The repairmen must drive trucks. America is a country on wheels and paying three times what they used to pay at the pumps is going to effect whether they take a vacation, buy clothes, go out to eat. Heck the many who were living on the edge of their budgets, could no longer keep up with their mortgages because they had to pay the credit card first so they could buy more gas to get to work. WAKE UP. Higher oil prices does effect our economy.

  6. NumbersDontLie | April 12, 2012

    I agree with Urani. You are looking at the effects on personal consumption only. Higher energy costs filter through the economy and raise the prices of everything. Food production is very sensitive to energy cost inputs…chemical production is very sensitive to energy costs…airline prices are 1/3 driven by fuel…steel production…need I go on?

    $200 oil will guarantee no growth for years which means no job growth and no consumption growth. Any other bad data point (declining gov't spending perhaps) will guarantee a recession.

    Cheap energy is the life blood of an economy.

    • Steve | April 12, 2012

      Cheap energy allows the common class access to resources. The elite are in opposition to the aspirations of the common class. Higher energy costs favorably differentiate the elite. There is no maximum to energy costs which decrease the circumstances of the elite. The elite are in control of energy and intend to remain in control.

  7. Gordan Finch | April 12, 2012

    Sorry, I must admit you are way off the mark on this one Martin, $200-oil-wont-cause-a-recession. It will instead cause a far greater depression than the last one.

    It is also quite clear the ECB IMF BIS cannot fund or print their way out of the mess in Europe and its being caused by Fuel Duty and VAT.

    The ECB cannot also be recapitalised ahead of Greeces departure from the Euro. If Spain and the EU is to be saved, a multi trillion € package of stimulous and devaluation of the currency must be implimented, regardless of the irrevocably fixed fraudulent value. Set by and dictated illegally on EU member countries– by the Bank of International Settlement, crooks in suits.

  8. James | April 12, 2012

    Cheap energy, is the only reason this economy has done so well in the past, with the energy costs rising , farmers have to charge more for food, mechandise that has to shipped around the country has to go up to recover the extra fuel costs. The poor and the middle class, who have not had a raise since 2007, still have to live on the same paycheck. Pal, you can only do without just so much, before you have to stop paying someone, to get the things you need, so that your family can survive. Have you been Wal mart or the grocery store lately?

  9. Ventura Leite | April 13, 2012

    I am astonished with the proposition of this article: "a $200 oil wont cause recession".

    I will only suggest you to take into count the annual bill Increase for imported oil, and then aply the impact on DGP . You will immediately see what huge reduction it will cause on GDP.

    It seems fantastic to me that you drive your conclusions on the – personnal expenditures on energy – ( PCE) percent increase, and forget the overall impact on the economy. It is unbelievable!

  10. Mike Dunn | April 13, 2012

    I don't know if Mr. Hutchinson has gone senile in his old age or whether he is just kidding around with the readers to see if their alert. Anyone with a minimal economic education can see the faults in his analysis-Mike

  11. Steve | April 14, 2012

    Wow! This must be the dumbest investment news article I have read since Rana Foroohar who writes the business page for Time Magazine.

    I'm in the Equestrian business and can tell you the destruction wrought upon our industry by high fuel prices beggers discription. The families we used to do business with are impoverished and getting worse. Thousands of horses have been destroyed because people could not longer keep them. And, I'm talking about the ones that KEPT their job.

  12. OBSERVER | April 18, 2012

    With analysis like that you should be working for Obama's economic team. They have also been wrong on EVERYTHING they have done or forecasted.

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