2006 report on what 1 year of $120 oil would do to the global economy
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(Sun, 11 May 2008 18:56:22 -0500 (CDT)) ---
What would $120 oil mean for the global economy?
Posted by Chris Vernon on May 11, 2008 - 7:15pm in The Oil Drum: Europe
Topic: Economics/Finance
Tags: cera, Economy, oil prices, recession, wescott [list all tags]
The pdf is a short report written by Robert F. Wescott and published in
April 2006 by Securing Americas Future Energy. It was written when oil was
~$60 a barrel and addressed a scenario where the price of oil surged to $120
due to coordinated terrorist attacks on global oil transport infrastructure.
Well, here we are, two years on at $120 oil (without the attacks) so its
worth revisiting the analysis in light of the conclusion:
The main conclusion of this note is that $120 oil would have profound
negative effects on the world economy and global financial markets.
...
Such oil prices would almost certainly precipitate a global recession.
Click to download pdf
The scenario is not identical to the present situation, Wescotts terrorism
induced $120 involves a rapid spike upwards however the analysis is based on
the $120 price being sustained for a year. This long term high price is
similar to todays situation.
The most interesting chart from the report shows world oil expenditure as a
percentage of world GDP:
Wescott points out that historically this metric has been in the range of 1-3%
and recessions have occurred when the expenditure exceeded 4%. $120 represents
approximately 8% of world GDP, higher than at any time in modern history. Two
studies are cited: The International Monetary Fund (IMF) suggesting a $5
increase cuts world GDP by 0.3% so it follows that the $60 to $120 doubling
would reduce world GDP by 3.6% and the US Federal Reserve estimates that a $20
increase reduces GDP by 0.75%, which would result in a loss of 2.3% from the
increase to $120.
With world GDP growth averaging 3.5% over the last 30 years we are clearly in
the ball park of a global recession due to oil price, before even considering
todays other difficulties in the credit and housing markets.
Wescott associated $120 oil with $5 a gallon gasoline in the US and $8-9 a
gallon in Europe. In April 2008 the average price of a US gallon of regular
petrol in the UK was $7.98 (April '08 national average 108.1p/litre and
assuming #1 = $1.95). In the US a gallon is $3.61 (EIA). How has he managed to
be right on one count but off when it comes to the US? Current retail prices
lag the oil price by several weeks and with low taxation the US price is more
sensitive to changes in the oil price. Prolonged $120 oil is certain to
increase todays US price by a larger proportion than the European price.
Wescott forecast that inflation would rise from 2-3% to 6-8% and that interest
rates would increase to combat this pressure. It was noted that as growth
slows the reverse decision may be taken to ease credit conditions. We seem to
have skipped the first stage of increased interest rates and moved straight to
cuts, in an attempt to break the credit crunch.
Whilst a radical claim two years ago $120 now seems conservative. This week we
have two new forecasts; in a major departure from previous downward
predictions Daniel Yergin of CERA is now suggesting $150 this year and Goldman
Sachs are talking about $200 within the next six-months to two years.
In conclusion, Wescotts paper makes some interesting observations and we seem
to be on the trajectory he identified. However three things are tempering
reality against the scenario presented:
a.. the value of the dollar has decreased somewhat so todays $120 is not as
high in comparable terms as Wescotts
b.. the rise from $60 to $120 has been a steady climb rather than the abrupt
terrorism induced shock and
c.. we are yet to experience the full year of $120 that the report assumes.
The core prediction is one of global recession, history suggest that and
whilst the Wall Street Journal article didnt use the 'r' word this paragraph
requires little further analysis:
"That would put oil at unprecedented price levels, even going back to just
after the Civil War," said Stephen Brown, an energy economist at the Dallas
Federal Reserve Bank. A sustained price of $150 a barrel, he estimates, would
shave around 1.8% percentage points off U.S. economic output in the first
year, and a further 1.5% in the second year. The U.S. economy in the first
quarter grew at an anemic 0.6% annual pace.
Wall Street Journal
[demime 1.01d removed an attachment of type image/png which had a name of wescott_report.png]
[demime 1.01d removed an attachment of type image/png which had a name of Wescott-1.png]
"Mark Graffis" (mgraffis@gmail.com).
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