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How Bad Is the Oil Shock of 2008?

by: James Hamilton June 06, 2008 | about stocks: AMR / CAL / DAL / F / GM / UAUA    

James Hamilton

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It's time to reassess the potential for recent oil price increases to contribute to an economic downturn.

The sharp spikes in oil prices associated with the 1973-74 oil embargo, the 1978 Iranian Revolution, the Iran-Iraq War in 1980, and the first Persian Gulf War in 1990 were each followed by an economic recession.

However, when oil prices started to rise again five years ago, many of us suggested that things would be different this time, in part because the price was rising much more gradually and so should be less disruptive of consumer spending patterns. Others emphasized that, despite the price increases, oil was still cheaper than it had been historically if you took into account inflation. However, once you include the most recent data, neither of those claims would still be true.

 

Average monthly dollar price of West Texas Intermediate (from FRED divided by ratio of contemporaneous to March CPI (also from FRED).
oil_price_jun_08.gif

Another reason consumers had been largely shrugging off the oil price increases of the last few years is that they could afford to do so, since energy expenditures had fallen so significantly as a fraction of total income. However, as a result of rising oil prices, that, too, is no longer the case. The graph below shows a rough estimate of the dollar value of U.S. crude oil consumed as a fraction of GDP. This ratio fell as low as 1.1% in 1998, but is up to 5.2% so far in the first quarter of 2008. And that's on the basis of the average 2008:Q1 oil price of $98 a barrel-- you'd pay $128 as of today.

One hundred times the ratio of (1) annual average of monthly WTI price per barrel (from FRED) times annual U.S. crude oil consumption (from EIA) to (2) annual nominal GDP (from BEA Table 1.1.5).
oil_to_gdp_jun_08.gif

 

We've reached the point where American businesses and consumers simply can no longer afford to ignore the price of fuel, and we're getting clear indications of real changes in behavior. Counts of the number of cars on the roads suggest that U.S. vehicle miles traveled fell 4.3% in March.

 

U.S. vehicle miles traveled in billions of miles, 12-month moving average. Source: Federal Highway Administration.
vmt_jun_08.gif

 

U.S. gasoline consumption so far in 2008 has been 70,000 barrels/day lower than in the first five months of 2007.

 

U.S. finished motor gasoline product supplied, 4-week averages, in thousands of barrels per day. Most recent year in red, previous year in blue. Data source: EIA
gas_demand_jun_08.gif

 

And sales of SUVs are crashing. Sales of light trucks manufactured in North America last month were 26% below the level of May 2007.

 

Data source: Wardsauto.com
dom_trucks_jun_08.gif

How do the challenges this poses for domestic automakers compare with what we observed in the 1990 oil price shock? BEA Table 1.2.6 indicates that the real value of U.S. motor vehicle production fell by $44 billion between 2007:Q3 and 2008:Q1, almost as large as the $49 billion drop between 1990:Q3 and 1991:Q1 following the oil shock associated with the first Persian Gulf War. Granted, autos were more important for the U.S. economy then than they are now, with $49 billion representing 0.7% of GDP in 1990 (or a 1.4% hit to the annual growth rate), whereas the $43 billion drop between 2007:Q3 and 2008:Q1 is little more than half the size of the 1990-91 shock relative to GDP.

On the other hand, the monthly auto sales data graphed above show that April and May marked a significant deterioration relative to 2008:Q1. BLS seasonally unadjusted establishment data indicate that the number of Americans employed in motor vehicles and parts manufacturing fell by 107,000 between April 2007 and April 2008, which is bigger than the 88,000 decline between April 1990 and April 1991. GM (GM) this week announced plans to close 4 North American plants, idling an additional estimated 8,000 workers. Ford (F) plans a 15% cut in its 24,000 salaried employees.

Continental Airlines (CAL) announced plans to cut 3,000 jobs in response to higher fuel prices, following similar announcements from United (UAUA), Delta (DAL), and American Airlines (AMR). Based on the experience in earlier oil shocks, we can anticipate that there will be broad changes in many other categories of business and consumer spending that will pose challenges to a number of affected industries.

We dodged a recession (at least through most of 2007) despite a dramatic housing downturn. The modern American economy could perhaps also continue to grow through the kind of effects we saw from the oil price spike of 1990. But what if we have to deal with both sets of problems at the same time?

I'm afraid we're about to find out.

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This article has 32 comments:

  •  
    Jun 06 05:52 AM
    if you are only waking up to this situation now,
    then you don't have enough time to get ready for what's coming.

    Are you starting?
    Reply
  •  
    Jun 06 06:22 AM
    If the american economy can stomach this too it will suprise the heck out of me the price of everything is going up oil is the fuel of capitalism and we can not survive at these levels or God forbid higher.this hey have the technology.To get what you want at the price you want to pay go to:seeksomething.com
    Reply
  •  
    Jun 06 06:47 AM
    If one uses genuine rather than government inflation statistics I believe the picture becomes clearer. I remember 1974. Oil has begun to affect behavior, but it has only begun to do so. The oil shock has only begun. People still drive SUV's, but some are starting to dump them. When this becomes a deluge, you'll know it hurts. When 80% or more of vehicles at the gas stations are compacts and subcompacts, you'll know. When you see a majority of J6P buying 5 or 6 gallons instead of filling up, you'll know. When the talk at the water cooler is totally dominated by gas prices, you'll know. When federal, state and local governments all start urging people to turn off lights and save energy, you'll know.

    We're nowhere near that yet. Years to go.
    Reply
  •  
    Jun 06 07:04 AM
    Paul Volker said ,several years ago , enjoy it while it lasts. this economy is headed for the sewer.
    Reply
  •  
    Jun 06 07:40 AM
    The effects of "economic cleansing" that antiseptic term of economists:
    Airline Industry: higher prices, grounded planes and layoffs and more bankruptcy or consolidation.
    Trucking Industry: Independent truckers are having their rigs repossessed and becoming an endangered species.
    Hotel/Travel/Entertain... Industry: Feeling the pain
    Real Estate Industry: Very painful
    Living in the suburbs with 1 hr + daily commute in SUV or truck with no public transportation. Becoming a credit card nightmare by living at the edge of the credit line.
    So much more without the sticker shock of food prices.
    Anyone for watching "happy Days" on DVD?
    Reply
  •  
    Jun 06 07:41 AM
    The effects of "economic cleansing" that antiseptic term of economists:
    Airline Industry: higher prices, grounded planes and layoffs and more bankruptcy or consolidation.
    Trucking Industry: Independent truckers are having their rigs repossessed and becoming an endangered species.
    Hotel/Travel/Entertain... Industry: Feeling the pain
    Real Estate Industry: Very painful
    Living in the suburbs with 1 hr + daily commute in SUV or truck with no public transportation. Becoming a credit card nightmare by living at the edge of the credit line.
    So much more without the sticker shock of food prices.
    Anyone for watching "happy Days" on DVD?
    Reply
  •  
    Jun 06 07:42 AM
    The effects of "economic cleansing" that antiseptic term of economists:
    Airline Industry: higher prices, grounded planes and layoffs and more bankruptcy or consolidation.
    Trucking Industry: Independent truckers are having their rigs repossessed and becoming an endangered species.
    Hotel/Travel/Entertain... Industry: Feeling the pain
    Real Estate Industry: Very painful
    Living in the suburbs with 1 hr + daily commute in SUV or truck with no public transportation. Becoming a credit card nightmare by living at the edge of the credit line.
    So much more without the sticker shock of food prices.
    Anyone for watching "happy Days" on DVD?
    Reply
  •  
    Jun 06 09:37 AM
    Oil is going higher! Matt Simmons thinks we are going to have supply disruptions. I write about ithttp://theinvestings... @
    Reply
  •  
    Jun 06 10:18 AM
    One only has to look down at your speedometer while complaining about gas prices going through the roof. Well? Are you going 80 mph on the freeway? Then, what you are seeing is supply and demand at work. What you have is "pedal-nomics&quo... you don't like it... do something about it. Don't complain, just slow down. LOL
    Reply
  •  
    Jun 06 10:23 AM
    The oil price shock is a bubble that we all see and feel, yet it hasn't popped. The US is facing a fairly significant growth in unemployment (see May data released today), the US autos are finally shifting production to smaller more fuel-efficient cars, and the housing market is declining world wide. The latter will have the most profound impact on demand, and therefore the consumption of oil.
    Reply
  •  
    Jun 06 11:00 AM
    Thank you for the excellent article. Opinions are good, but opinions backed up with data are much better.
    Reply
  •  
    Jun 06 11:02 AM
    youtube.com/watch?v=Sd...
    Reply
  •  
    Jun 06 11:10 AM
    I find all the social commentary amusing, but irrelevent. Bakken oil shale, Canadian oil sands, ANWR, drilling 5 miles off Biscayne Bay, my evil imperialist capitalist views on the world etc. etc. etc. We get it, there is more oil, and high prices will bring some or all of this online over time. The problem there is the market is not elastic, the only people that can bring 2MM bpd on tomorrow are in the midde east. Further, those people have said they like prices right where they are now.

    The USA is a functional supply and demand marketplace, yet the price of oil continues to rise, thus we are not the culprit. I think it's great that US demand is clearly decreasing, but again, look at price. We are not driving the market.

    Nearly half the world's population purchases oil in NON supply and demand marketplaces where the price is fixed or modified by the local governments (see: India, China, most of the Middle East, Malaysia, Venezuala, etc.)

    Because all of those governments are pumping money into oil subsidies at close to a billion dollars a day, speculators are irrelevent. Said governments actions have affect of driving up demand, which is what speculators depend on. As I've said before: (speculators : supply and demand) as (amplifier : guitar).

    So, keep track of news regarding subsidy modifications. In the last week Malaysia and India have both moved towards lifiting their subsidies, once China blinks the bubble will burst.
    Reply
  •  
    Jun 06 12:03 PM
    It is amazingly stupid for the Saudis to increase production. Why sell 12m barrels for $115 when they can sell 10m barrels eventually $135. More money for less work.... oh, uh, I forgot that is we do here in America.... Let the rest of the world do the real work, and we can just sit around waiting for the fruit of they labor. Things are turning upside down.
    Reply
  •  
    Jun 06 12:08 PM
    www.youtube.com/watch?...
    Reply
  •  
    Jun 06 12:37 PM
    We received another wakeup call this week when it was reported elsewhere that population increases and prosperity would require the world to produce 50% more food in the next couple of decades. It doesn't take advanced analysis to see dramatic consequences from this for all countries and economic sectors. The other commodities, including petroleum, used in current food production methods will face competition for supply and inevitable price increases...
    Reply
  •  
    Jun 06 04:02 PM
    this is a big problem folks...today was insane...wow
    Reply
  •  
    Jun 06 07:29 PM
    While at a stop light today, I counted eight gas hogs and two compacts which passed. Five of those were on the phone, and only one had two people in the vehicles. We are using our crops to make a fuel alternative which accounts for only 3 per cent of the fuel used and the EPA turned down an expansion project for a major oil company today because it did not like the flare stack set-up. Try building a new refinery or even better building an atomic power plant. There are no quick fixes and we need to drill for oil in locations that have not allowed it before or they can go cook their food on a wood cook stove. We need a responsible energy policy which is fair and will work. Why don't we have that? Because politics, power & money dictate who gets what and the average American consumer is in the middle.

    Hang on to your gas cap, your money and savings are going to go for increased fuel, food and taxes. We are not the only Country who is needing energy, India (TaTa Motors) is introducting the $2,500 car for the people of India (henry ford of India) and in the meantime, China is coming on strong. "Why is it Toyota can build a great car int he U.S. and Ford is just now saying we are now equal to Toyota. Shame on us and our spoiled labor force. As a result, Companies are closing US plants and getting tax incentives to open ones overseas with cheaper labor. Will the last American Auto worker in Detroit, please turn out the lights.

    Unlike most Americans, I believe we can come back, but in the next few years it is going to take a new look at energy, food, and jobs in America to get us out of this mess. Face it, "its not a great time" Its time to get back to the basics and use some common sense. In the meantime, crude is going to $150.00 and gas will be $5.50 in Sept. Don't forget about the U.S. Hurrican Season on the Gulf Coast.

    Lastly, there is probably at least $25.00 bbl of the price based on Merc trading and hedges. Part of that is uncontrolled in London and Dubai. If you are an overseas producer and decide to make a bullish statement, what position would you take the day before the announcement?
    Reply
  •  
    Jun 07 12:28 AM
    VP of Common Sense: I must say I agree--a refreshing post.

    I am not bothered by those that pedal doom and gloom--I need them. The collective pessimism of others has helped me build a great portfolio!
    Reply
  •  
    Jun 07 08:18 AM
    Purely for entertainment:

    We do have a functional energy policy... USE OIL!
    Reply
  •  
    Jun 07 08:23 AM
    this is a terrorist attack on the us economy by mideast oil countries
    they hate us and their control of oil and oil prices is part of a plan
    to drive the american economy into the tank.
    thank you george w(acko) bush
    Reply
  •  
    Jun 07 09:03 AM
    Oil got to the $80-90 range on supply/demand basis. About the same time (August 07) the housing bubble really starting bursting in earnest. Banks and brokerages going broke, enter soveriegn wealth funds from the mid-east and asia. Oil goes from $85 to $135 due to speculation. Any connection? Send responses to the grassy knoll.
    Reply
  •  
    Jun 07 09:25 AM
    The Fed is responsible for the oil shock along with the US govt and Israel / Iran stand off on nuclear weapons.

    1. Attempt to print the way out of the housing crisis is the cause of the oil bubble ( is it really one ?) . too many dollars running after oil ?? a detailed analysis of which funds backed by which banks are driving the oil futures and it will be plain as american pie for all ....

    2. keep the middle east tension as the prong for mantaining high oil prices : 1. dollar devaluation implicit 2. export inflation 3. boost american exports - reason being to offset the dollars printed to bail out banks / sub prime loans ,,.....

    3.The Era of subsidies is over - there is no more a free meal for any body . The quicker the govts reduce subsidies - the better they may survive as a nation - or they will be wiped out through economic warfare. who needs nukes now a days - we have a more ecological way of maintainng hegemony..

    4. The buubles are economic weapons of mass destruction and I dont see any body hauling the responsible to the courts ....

    5. Obviously the threat ( oil / middle east : alias energy security / food security ) has been identified and a well definied strategy has been put in place and being executed to ensure the freedom of the market place in to the next century irrespective and regardless of who is paying for it.

    6. GOD BLESS AMERICA.
    Reply
  •  
    Jun 07 11:16 AM
    The problem is not the price of oil. Oil is an amazing store of energy with potential way beyond our current usages. The problem is that oil has been undervalued for so long that this revaluation is calamitous.

    If we continue to ignore public transportation then our situation will only become worse. If we continue to waste energy then we will decline as a society until we have nothing left to waste. How many countries store 50 gallons of hot water in every home 24/7? Only North America. How much energy will we save if millions of homes just replace wasteful water heaters for efficient flash heaters? The next time you fly at night observe all the parking lots that are empty and fully lit. The good news is that we have easy efficiency gains out there for the taking and they will create jobs in the process. Bill Clinton said that the efficiency gains from IT were responsible for the booming economy under his term. Maybe the next administration will be wise enough to encourage the retrofitting of America's infrastructure and prosper as well.
    Reply
  •  
    Jun 07 12:06 PM
    Good data filled post and a batch of really good comments. The US and perhaps Canada will be the countries that suffer the most as our current modus vivendi crashes to be replaced by godknowswhat. For the near term we need a crash program to electrify mass transport, retool and rebuild our creaky grid and try to decide what to do with our soon to be depopulated distant suburbs. Anybody out there need some slightly used Romex and copper pipe?
    Reply
  •  
    Jun 07 02:59 PM
    @oliver stone, that sounds like a conspiracy, no surely not!
    Reply
  •  
    Jun 07 07:04 PM
    blocks, if it's a terrorist attack, we're in trouble. It looks like Canada and the UK are involved too, since they charge market prices for oil. Watch out for Texas and those oil wells in California and Alaska--they're on it it too! :D
    Reply
  •  
    Jun 08 02:27 AM

    There's one other major factor at work here that wasn't present during the earlier energy crises the author describes... The self-imposed domestic energy exploration and production embargo being imposed on us by our own Congress.
    Reply
  •  
    Jun 08 09:55 AM
    Thanks for the great analysis. It is wonderful to open up a page
    and have this type of historical information, along with a great interpretation! It will be interesting to see how it all plays out!
    Reply
  •  
    Jun 08 11:57 PM
    PaulK, it's gonna take more than lifting the often thrown around "theory" of a "self-imposed domestic energy exploration and production embargo ".

    Fact is, that's not enough oil, in enough time, to save this economy.

    We should have come up with agressive measures five years ago to reduce not only foreign, but also domestic oil consumption in this country. Now we're obviosly a "bit" behind the power curve.

    That would have been real leadership.

    I"ll never forget the day I saw Bush on tv say "I don't think AMericans should be forced to drive smaller, less safe cars..."

    Priceless...

    Let's all pray that the "oil price over-sensitivity to decrease in demand" theory has some merit. Because one way or the other, demand will be falling in this country.

    It's already started.
    Reply
  •  
    Jun 09 02:03 PM
    1. Leadership. Leadership at all levels and in all walks of lives and communities.
    2. Good conscience. Imagine if every citizen or resident proactively contribute his/her share, what's no to overcome?
    3. Collective power. Why not utilize all these talents collectively? We have the largest pool of smart and practical brain power in the World, don't we? We need to pull these people together.
    When the world changed after 911, when we are under attack in so many angles, the status changed. Don't surrender to this mess! Ask not what others can do for you, ask what you and your corporation can do for your own country!
    Do we have that spirit? We used to.
    When Asian financial crisis hit Asia a few years ago, Korean Airlines' flight attendants jointed other citizens at their airport in Seoul to ask people not to leave their own country so their money will be spent inside their own country.
    Right now in Taiwan, the Mayor of Kaohsiung is offering free ride on all their public buses. The government in Taipei is offering 20% raise for their employee in helping them overcoming oil crisis.
    And their citizens responding actively in efforts to reduce energy consumption.
    Just to list a few. What are we going to do?
    Reply
  •  
    Jun 28 06:05 PM
    I'm off to see if there are any unused clichés left! ;)


    On Jun 09 02:03 PM Independent E.G. wrote:

    > 1. Leadership. Leadership at all levels and in all walks of lives
    > and communities.
    > 2. Good conscience. Imagine if every citizen or resident proactively
    > contribute his/her share, what's no to overcome?
    > 3. Collective power. Why not utilize all these talents collectively?
    > We have the largest pool of smart and practical brain power in the
    > World, don't we? We need to pull these people together.
    > When the world changed after 911, when we are under attack in so
    > many angles, the status changed. Don't surrender to this mess! Ask
    > not what others can do for you, ask what you and your corporation
    > can do for your own country!
    > Do we have that spirit? We used to.
    > When Asian financial crisis hit Asia a few years ago, Korean Airlines'
    > flight attendants jointed other citizens at their airport in Seoul
    > to ask people not to leave their own country so their money will
    > be spent inside their own country.
    > Right now in Taiwan, the Mayor of Kaohsiung is offering free ride
    > on all their public buses. The government in Taipei is offering 20%
    > raise for their employee in helping them overcoming oil crisis.
    >
    > And their citizens responding actively in efforts to reduce energy
    > consumption.
    > Just to list a few. What are we going to do?
    Reply
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