Oil Prices — Too Low For Too Long
Kurt Brouwer July 10th, 2008
Source: Dallas Federal Reserve Bank
Oil Prices — Too Low for Too Long
Now, you might think this chart is all about how high oil prices have gone recently, but you’d be wrong. Obviously, they have gone up a lot lately, but the main point I think we need to focus on is that oil prices were too low for far too long. Looking at the orange line, nominal or actual prices remained essentially flat from 1985-2001. At that point, they began rising as demand caught up to supply and even exceeded it. But, for decades oil prices lagged far behind increases in the cost of living.
In this chart from a report released by the Dallas Fed in May of this year, you can see the blue line (oil adjusted for inflation and priced in 2008 dollars) remained far above the price for oil for decades. This chart ends in May, but if it were produced today, we would finally see that the nominal price of oil (orange line) would be above the blue line or inflation-adjusted price for oil. This piece from the New York Times makes the same point [emphasis added] and it includes a link to the Dallas Fed paper.
Dispelling the Myths of Summer (New York Times, July 2, 2008, David Leonhardt)
…The second big myth is the one that has been occupying Congress — the idea that the spike in oil prices is a big mystery that can be explained only by market manipulation. Other writers have done a nice job of debunking the manipulation argument. I’ll stick to the reasons why the run-up, abrupt as it may feel, isn’t mysterious.
The world is now at the end of a 20-year energy cycle. From the mid-1980s to the middle of this decade, oil prices fell even as the world economy grew. A barrel of crude cost $68 in 1983 (adjusted for inflation) — and just $33 in 2003.
How did this happen? The high prices of the early 1980s gave producers an incentive to take more oil out of the ground and also gave consumers reason to use less of it. With supply growing quickly and demand growing less quickly, prices plummeted.
The low prices of the 1990s reversed those incentives. Americans fell in love with Hummers and pickup trucks, and the Chinese and Indian booms were fueled by cheap energy. Oil supplies, meanwhile, weren’t growing so quickly. To top it off, the decline of the dollar since 2001 has reduced Americans’ purchasing power. Without that fall, a barrel of oil would cost less than $110 today, rather than $141, according to Stephen P. A. Brown at the Federal Reserve Bank of Dallas.
Oil prices may well fall at some point. But no speculation-hating senator can legislate oil back to $26 a barrel. It will stay expensive until the fundamentals — supply and (more important, for the sake of the planet) demand — change…
One point that is not mentioned in this piece is that both China and India heavily subsidized the price of gasoline in their countries so even as prices rose, consumers were shielded from the full impact of higher prices. Both countries have recently announced reductions in the subsidy and this will no doubt slacken demand in those countries.
Also, demand is falling here at home too. Americans are driving less and buying smaller, more efficient cars so that should be positive. As demand slackens, we should see oil prices stabilize and even fall at some point. However, we are not likely to see a return to the really low prices we saw in the 1990s and early 2000s.
Another problem that has heightened the impact of rising oil prices is the decline of the dollar. This chart illustrates the double whammy Americans have experienced — rising prices for oil exacerbated by the impact of the falling dollar.
Source: Dallas Federal Reserve Bank
If the dollar had held its value from 2001 on, the price of a barrel of oil for Americans would be considerably lower. However, that is a big if because the dollar was at a historical high point in 2001. Just as the low price of oil and the strong dollar contributed to the low cost of oil products in the 1990s and early 2000s, we have now felt the pain of adverse trends in both oil and the dollar. However, nothing lasts forever and I believe we are seeing early signs that change is on the way.
For more, see How Far Has the Dollar Fallen? And Why? — What’s Next?
For more on energy issues, see A New Strategy for Energy Independence — T. Boone Pickens and Why Are Food & Fuel Prices Soaring? and GASENFREUDE.
- Economy , Geopolitics , Money
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