The oil shock of 2008

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).

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).

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.

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

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

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 this week announced plans to close 4 North American plants, idling an additional estimated 8,000 workers. Ford plans a 15% cut in its 24,000 salaried employees.

Continental Airlines announced plans to cut 3,000 jobs in response to higher fuel prices, following similar announcements from United, Delta, and American Airlines. 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.