No Oil Price Shock Yet?

Prof. James Hamilton is one of the smarter economists out there who exhibits a lot of common sense. Remember what the author Gertrude Stein once said, that “everyone gets so much information all day long, they lose their common sense?”

Common sense is needed now when it comes to the debate about an oil shock from the crisis in the Middle East.

Prof. Hamilton, who is with the University of California in San Diego, says essentially not to worry. We know that Libya’s output is about 2% of worldwide oil production. Prof. Hamilton though says that if Libya’s oil fields get knocked offline, it would be a tiny hit, equal to only about half of the smallest of the top five oil price disruptions in the last sixty years. Here are the five oil shocks:

Suez Crisis, Nov. ‘56 - Lost 10% of outputOPEC embargo Nov. ‘73 - Lost 7.5%Iranian Revolution Nov. ‘78 - Lost 7%Persian Gulf War Aug. ‘80 - Lost 9%Venezuela unrest, Gulf War II, Dec 2002 - Lost 4%

But what happens if oil shoots higher in increments of $10? What does that equate to in terms of a hit to consumer wallets?

Prof. Hamilton adds: “Americans consume about 140 billion gallons of gasoline each year. I use the rough rule of thumb that a $10/barrel increase in the price of crude oil translates into a 25 cents per gallon increase in the price consumers will eventually pay for gasoline at the pump. Thus $10 more per barrel for crude will leave consumers with about $35 billion less to spend each year on other items, consistent with a decline in consumption spending on the order of 0.2% of GDP in a $15 trillion economy.”

However, he also says that each of the last five significant economic downdrafts was immediately preceded by a huge spike higher in oil prices. Sometimes the price spike was due to supply constraints, like in the ‘70s and in 1990, Hamilton says. Other times, as in 2008, it was due to surging global demand for oil.

But still the world economy is very weak. So watch what Hamilton says here. He says “With the global average price of oil having moved above $100 per barrel in recent days – about 33 per cent higher than the price last summer – it is natural to fear that this latest oil shock may be enough to kill the global economic recovery. But oil prices would have to rise much further, and persist for much longer, for these fears to be justified.”