The New Oil Shock

The jump in crude oil prices is a disturbing reminder of the kinds of shocks in the 1970s that led to a stunning boom in inflation and grinding economic slowdowns. Can we expect a similar outcome?

Crude oil future have risen 21% since Russia’s invasion of Ukraine and the sanctions that followed. Today, they surged nearly 7%, to $110.60 a barrel, the highest settlement since May 3, 2011.

Russia exports 7.5% of the world’s oil, and while its supply has not been disrupted by sanctions, refiners and others are spurning Russian crude and so the market is acting as if it has been disrupted. As a result, oil prices seem unlikely to slow their advance any time soon.

“Unless Russia quickly returns its troops to the barracks, it looks like the only way is up for oil prices,” Helima Croft of RBC Capital Markets wrote today.

If U.S. oil gets to $119 a barrel, that would mean the price has doubled in a year’s time. The last three times that has happened, notes Nicholas Colas, co-founder of DataTrek Research, the U.S. economy soon found itself in a recession: in 1990, 2000, and 2008.

The pain of a spike in energy prices is quickly transmitted to U.S households in the form of higher prices at the pump and in heating bills. With consumer spending accounting for two-thirds of the U.S. economy, the possibility of higher costs dragging down growth looms large. Mark Zandi, chief economist at Moody’s Analytics, recently estimated that oil at $100 a barrel would subtract a 10th of a percentage point from GDP growth in the second quarter and half a percentage point in the third quarter.

Yet as Avi Salzman of Barron’s explains, American consumers may be able to withstand more of the price shock than they have in the past. Avi wrote:

Importantly, households have more savings than in prior years and can potentially absorb increases for a while longer. J.P. Morgan economist Peter McCrory noted in a recent report that every 10% increase in gas prices adds $4 billion in costs to consumers and every 10% increase in oil prices adds $19 billion. Consumers could choose to cut back in response, but McCrory writes that they may instead dip into savings and continue their spending at previous levels. He sees U.S. GDP rising 1.5% in the current quarter.

Avi also notes that in Colas’s three examples of recessions, there were also other, arguably more important factors: the Kuwait war in 1990, the bursting of the dot-com bubble in 2000, and of course the financial crisis of 2008. Still, the rise in oil prices could have made the economy more vulnerable, Colas contends.

“The interesting question is whether we would have had a recession anyway, although perhaps not as bad, just due to oil prices,” [Colas] wrote. “Business cycles are funny that way: you get to the end of a long run and exogenous shocks hurt more than if they had occurred early to mid-cycle.”

Read the rest of Avi’s article here.