Will Arab Oil Save Us from a Double Dip?

It might seem too much like common sense, but disruptions in oil-producing regions have tendency to drive up the price of oil. Duh-oh! The Arab Spring embraced regime change in several countries and threatened others where significant petroleum reserves are centered, and the oil markets reacted predictably. What appears to be even more significant is the apparent correlation between expensive oil and economic collapse. University of San Diego Economist James Hamilton released a paper this past January examining this link.

In his own summary of that paper, he wrote: “[Hamilton’s study collected] the price increases of 1973-74 together, though in many respects the shortages in the spring of 1973 and the winter of 1973-74 were distinct events with distinct causes. The modest price spikes of 1969 and 1970 have likewise been grouped together for purposes of the summary.... These historical episodes were often followed by economic recessions in the United States. [Hamilton also reported] the starting date of U.S. recessions as determined by the National Bureau of Economic Research. All but one of the 11 postwar recessions were associated with an increase in the price of oil, the single exception being the recession of 1960. Likewise, all but one of the 12 oil price episodes … were accompanied by U.S. recessions, the single exception being the 2003 oil price increase associated with the Venezuelan unrest and second Persian Gulf War.

“The correlation between oil shocks and economic recessions appears to be too strong to be just a coincidence … although demand pressure associated with the later stages of a business cycle expansion seems to have been a contributing factor in a number of these episodes… Moreover, supply disruptions arising from dramatic geopolitical events are prominent causes of a number of the most important episodes. Insofar as events such as the Suez Crisis and first Persian Gulf War were not caused by U.S. business cycle dynamics, a correlation between these events and subsequent economic downturns should be viewed as causal. This is not to claim that the oil price increases themselves were the sole cause of most postwar recessions. Instead the indicated conclusion is that oil shocks were a contributing factor in at least some postwar recessions.”

Clearly, with the possibility of a double-dip looming, oil demand has dropped off… for now. And with the regime change in Libya, all eyes are on that petroleum producing nation: “With the Libyan Civil War winding down the question on the rebels’ NATO allies now becomes: ‘When can we bring the oil fields back online?’ It wasn’t until the Arab Spring arrived in Libya that worldwide oil prices really began to fluctuate, as the country's output of light sweet crude quickly dwindled from 1.3 million barrels a day to a mere 60,000, a loss equivalent to five percent of Europe’s total supply, or more than 15 percent of Italy’s, France’s, Switzerland’s and Austria’s.

“Unfortunately, the answer is: not any time soon. OPEC officials, oil analysts, and Libya’s former oil minister Shokri Ganem (who defected three months ago) all agree that restoring production to its previous levels will take years--until 2013 or 2014 at the earliest. With sufficient repairs, the country could produce 4000,000 barrels a day in a few months, Ghanem told Platts, an oil industry publication, but that still leaves a global shortfall of almost a million barrels a day.” FastCompany.com, August 25^th.

Still, the mere sign of possible stability, that oil may be online again and flowing, sent oil prices down. But increasing demand, particularly from high industrial and car-ownership growth from nations like India and China, could put the squeeze back on. The potential disruptions that could arise from a positive UN General Assembly vote recognizing Palestine as an independent state – and the civil disturbances that might flow from such an event – might also add another glitch to this already-sensitive market.

Trying to pin depressions and recessions on any single event or even a series of events is clearly folly. There is complex interplay among all of the relevant variables. But when scales are already tipping in one direction or another, a big variable is all the market needs to go all the way. What’s the message in all of this? More of the same. To budget cutters, beware: understand the difference between spending that produces real longer-term value (like infrastructure, education and research – we call that “investment”) and supporting expensive programs (like wars without any real benefit to the United States) as money that will never generate a future benefit to the country. Cut accordingly or risk vastly higher costs in the future. We do need research and support for alternative energy programs… or we can simply ride the tides of Middle East disruption, likely to continue, and watch the ebb and flow of our economic future move beyond our control.

I’m Peter Dekom, and wouldn’t be nice if our leaders would lead and stop being simply reactive?