What oil price can America afford?

The question of what oil price the US can afford is not a new one. But as oil prices rise it is becoming more urgent to find the right answer.

Steven Kopits of Douglas Westwood Energy research discusses this urgency in a new report, noting that in the last 37 years, the US has suffered six recessions. From the beginning of each, he says, oil played a central role. In every case when oil consumption breached 4 per cent of GDP, he notes, the US has suffered a recession. Indeed, he says, the current US recession began within two months of oil hitting the 4 per cent threshold, when oil reached $80 per barrel.

Kopits also notes that a sustained rise in the oil price of 50 per cent or more has always been associated with recession, and this applies to the current recession as well.

From his research, then, it seems there are three rules by which to avoid recession caused by oil prices:

Crude oil expenditures should not exceed 4 per cent of GDP.

Oil prices should not increase by more than 50 per cent year-on-year.

Oil price increases should not be so great that a potential demand adjustment should have to reach 0.8 per cent of GDP on an annual basis, as shedding demand at this rate has generally been associated with recession.

Kopits notes that these rules can be applied to three alternative approaches to oil and climate policy – both high on the Obama Administration agenda.

The US government can either prioritize climate policy with economic impacts secondary; prioritize climate policy while taking a cautious approach to the economy; or prioritise economic well-being, with climate policy secondary.

He notes there are advantages and disadvantages with each policy. But, at the end of the day, it is not up to Kopits. He rightly says that the administration has to decide whether climate change is the most important matter at hand, in which case any energy-induced recession is worth the price; or whether the health of the economy is of paramount importance, and any climate policy must be subordinate to that.

But he makes a strong case for heeding the lessons of history, noting that the oil price is rising, and the recession threshold is $80 per barrel:

Oil prices do not have to rally very much to reach unsustainable levels for the US economy.

EU to Opec: $70 oil is okay (FT Energy Source, 23/06/09)
Roubini warns of oil double-whammy (FT Energy Source, 22/06/09)
Brown’s fear of high oil prices (FT Energy Source, 22/06/09)
Rising crude and inflationary expectations (FT Energy Source, 16/06/09)
What Monty Python can tell us about commodities
(FT Energy Source, 15/06/09)

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