11

Oil and the EconomyOil and the Economy

Christopher J. NeelyChristopher J. Neely

Assistant Vice-President, FRB Saint LouisAssistant Vice-President, FRB Saint Louis

Presentation to the Ballwin Rotary ClubPresentation to the Ballwin Rotary Club

April 22, 2008April 22, 2008

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DisclaimerDisclaimer

The views expressed are my own The views expressed are my own and do not necessarily reflect and do not necessarily reflect official positions of the Federal official positions of the Federal Reserve Bank of St. Louis, or the Reserve Bank of St. Louis, or the Federal Reserve System.Federal Reserve System.

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What to talk about today? What to talk about today?

Current eventsCurrent events

Oil and the real economyOil and the real economy

Oil and gasoline pricesOil and gasoline prices

Lessons for the climate change debate Lessons for the climate change debate

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Current EventsCurrent EventsOil Prices have risen since 2002. Oil Prices have risen since 2002.

– The international security situationThe international security situation

– Growth in global, primarily Asian, economies.Growth in global, primarily Asian, economies.

http://stlouisfed.org/publications/re/2007/b/pages/oil_prices.htmlhttp://stlouisfed.org/publications/re/2007/b/pages/oil_prices.html

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Current EventsCurrent EventsSpot Oil Price: West Texas Intermediate ($/Barrel): 2000-2008:03

0

20

40

60

80

100

120

2000 2001 2002 2003 2004 2005 2006 2007 2008

US

D/b

bl

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Current EventsCurrent EventsChinese Oil consumption (Thousands of barrels/day)

0

1000

2000

3000

4000

5000

6000

7000

8000

1975 1980 1985 1990 1995 2000 2005

Thou

sand

s bar

rels

/day

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Current EventsCurrent Events

Oil companies make money when oil prices rise. Oil companies make money when oil prices rise.

Oil is their major asset. Oil is their major asset.

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Real Oil Prices and Petroleum Industry Profits

0

20

40

60

80

100

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Rea

l oil

pric

e in

Q2.

2007

dol

lars

, def

late

d by

CP

I

-20

-10

0

10

20

30

40

Quarterly data through Q1.2007 (profits), Q2.2007 (oil price)

Pet

role

um a

nd c

oal i

ndus

trie

s' p

rofi

ts a

s pe

rcen

t of

all n

on-f

inan

cial

cor

pora

te p

rofi

ts

Real oil price: WTI spot price expressed inQ2.2007 dollars, deflated by CPI (left axis)

Petroleum and coal industries' profits as shareof all non-financial company corporate profits(right axis)

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Current EventsCurrent Events

Inflation-adjusted oil prices are now just a little Inflation-adjusted oil prices are now just a little higher than in 1981. higher than in 1981.

1010

Yearly World Oil Prices ($/bb) World: Avg. Crude Price of UK Brent/Dubai/Alaska

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

100.00

1967 1972 1977 1982 1987 1992 1997 2002 2007

$/b

bl

Real Crude Oil Price

Nominal Crude Oil Price

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Oil and the real economyOil and the real economy

Rising oil prices often are associated with recessions.

James Hamilton (UCSD) has shown a strong relationship between oil and recessions.

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Oil and the real economyOil and the real economy

Spot Oil Price: West Texas Intermediate [Prior'82=Posted Price]$/Barrel

Civilian Unemployment Rate: 16 yr +SA, %

0500959085807570Sources: Wall Street Journal, Bureau of Labor Statistics /Haver Analytics

80

60

40

20

0

12

10

8

6

4

2

Spot Oil Price: West Texas Intermediate [Prior'82=Posted Price]$/Barrel

Civilian Unemployment Rate: 16 yr +SA, %

0500959085807570

Sources: Wall Street Journal, Bureau of Labor Statistics /Haver Analytics

120

100

80

60

40

20

0

12

10

8

6

4

2

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Oil and the real economyOil and the real economyWhy have rising oil prices caused recessions?Why have rising oil prices caused recessions?

– If input prices change, then If input prices change, then

firms change the types of capital and labor employedfirms change the types of capital and labor employed

and consumers will change their consumption bundles. and consumers will change their consumption bundles.

Rising oil prices will also redistribute wealth from oil Rising oil prices will also redistribute wealth from oil consumers, to oil producers.consumers, to oil producers.

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Oil and the real economyOil and the real economyU.S. consumption as a proportion of GDP

0

0.02

0.04

0.06

0.08

0.1

0.12

1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

The U.S. economy has resisted recession, despite the rise in oil prices since 2002.

– Recession might be in our present and/or future but we haven’t observed one yet.

Oil expenditures are now is a smaller share of U.S. nominal output.

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Oil and the real economyOil and the real economyOil Consumption per Unit of Real GDP

0

0.5

1

1.5

2

2.5

3

3.5

4

1967 1972 1977 1982 1987 1992 1997 2002

How much oil does the U.S. consume per unit of real output?

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Oil and the real economyOil and the real economy Oil imports have become an even more important Oil imports have become an even more important share of U.S. consumption since the first calls for share of U.S. consumption since the first calls for “energy independence” in the 1970s. “energy independence” in the 1970s.

U.S. producers are relatively high cost producers. U.S. producers are relatively high cost producers.

We could produce more oil domestically, but at a We could produce more oil domestically, but at a higher cost than we could import it. higher cost than we could import it.

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Oil and the real economyOil and the real economyUS Production, Imports and Consumption

0

5,000

10,000

15,000

20,000

25,000

1967 1972 1977 1982 1987 1992 1997 2002

Tho

usan

ds b

arre

ls/d

ay

US Cons of Oil (thousands of barrels/day)

US Oil Production (thousands of barrels/day)

US Imports (thousands of barrels/day)

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Oil and gasoline pricesOil and gasoline prices

Why do gas prices change when oil prices change?Why do gas prices change when oil prices change?

– Crude oil is a major (and volatile) component of Crude oil is a major (and volatile) component of gasoline prices. gasoline prices.

http://stlouisfed.org/publications/re/2007/c/pages/gas-prices.htmlhttp://stlouisfed.org/publications/re/2007/c/pages/gas-prices.html

– If oil prices rise, the cost of producing gasoline rises and so does If oil prices rise, the cost of producing gasoline rises and so does its price. its price.

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Oil and gasoline pricesOil and gasoline pricesWhy do expectations change gas prices? Why do expectations change gas prices?

(The oil in the tanks has been already purchased.)(The oil in the tanks has been already purchased.)

– Oil is a storable commodity: Spot and futures prices Oil is a storable commodity: Spot and futures prices are linked. are linked.

Higher expected prices cause sellers to sell less today and Higher expected prices cause sellers to sell less today and store more for tomorrow. store more for tomorrow.

This is good! It enables smoother consumption during This is good! It enables smoother consumption during disruptions. disruptions.

http://stlouisfed.org/publications/re/2007/c/pages/gas-prices.htmlhttp://stlouisfed.org/publications/re/2007/c/pages/gas-prices.html

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Oil and gasoline pricesOil and gasoline prices

An implication for An implication for forecasters: forecasters:

Futures price contain no Futures price contain no information about information about expected future spot expected future spot prices that isn’t in prices that isn’t in current spot prices, current spot prices, interest rates and storage interest rates and storage costs. costs.

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Prices are signalsPrices are signalsRising prices indicate either rising demand or Rising prices indicate either rising demand or falling supply (or both). falling supply (or both).

High prices encourage more production and less High prices encourage more production and less consumption, preventing shortages. consumption, preventing shortages.

Prices are usually the best way to ration scarce Prices are usually the best way to ration scarce goods and services. goods and services.

– Buyers are the most willing (and able) to pay. Buyers are the most willing (and able) to pay.

Redistribution of initial wealth can achieve Redistribution of initial wealth can achieve “fairness” goals within a price system. “fairness” goals within a price system.

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Lessons for global warmingLessons for global warming

Let’s stipulate—without debating—the following: Let’s stipulate—without debating—the following:

– Climate change is happening.Climate change is happening.

– Human COHuman CO22 emissions are substantially responsible. emissions are substantially responsible.

– The increase in temperature/ COThe increase in temperature/ CO22 is a bad thing, on is a bad thing, on

balance. balance.

– Reducing COReducing CO22 emissions is desirable. emissions is desirable.

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Lessons for global warmingLessons for global warming

Conventional price theory would support taxes on Conventional price theory would support taxes on COCO22 production/emission. production/emission.

Taxes should be introduced gradually.Taxes should be introduced gradually.

We can use the COWe can use the CO22 tax revenue to reduce other tax revenue to reduce other

taxes that distort behavior, like income taxes. taxes that distort behavior, like income taxes.

A tax will discourage consumption and encourage A tax will discourage consumption and encourage alternative sources of energy. alternative sources of energy.

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Lessons for global warmingLessons for global warming

Rationing/mandates are very costly & often Rationing/mandates are very costly & often ineffective. ineffective.

– Lines for concert tickets are wasteful. Lines for concert tickets are wasteful.

– CAFÉ standards spawned the SUV industry. CAFÉ standards spawned the SUV industry.

COCO22 cap-and-trade systems amount to gifts to the cap-and-trade systems amount to gifts to the

polluters. polluters.

– One could auction off permits to create COOne could auction off permits to create CO22. That . That

would produce effects similar to a tax. would produce effects similar to a tax.

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The EndThe End