Why Oil Prices haven't Crippled the US Economy Yet Updated Sept 18, 2006
by Tim McMahon
The above chart shows why oil prices have not yet put as big a crimp in our budgets as it did back in 1980. Back then the monthly average price peaked at $38 per barrel (although the intraday prices spiked much higher).
The common price quoted is for the all time high of Oil prices is the price that the highest barrel ever sold for. That price doesn't really have any effect on the price consumers paid. What really matters is the average price the refineries had to pay for the whole month.
Adjusted for inflation in September 2006 dollars this $38 peak is the equivalent of paying $100.52 today. This number is constantly changing as we adjust for inflation at the current moment.
In other words, Oil would have to average $100.52 for the entire month to be as high as the price we saw in December of 1979. But we are "only" paying about one half that amount.
Another factor that makes the Oil price worse in 1979 is the fact that back in '79 interest rates were two to three times higher than they are now, peaking in the high teens. Combine lower mortgage rates with lower taxes and the modern household actually has $500 extra cash available each month... which will buy a lot of gasoline.
Another key issue is that unemployment rates for workers with four years or more of college are running much lower than the overall unemployment rate at about 1.5%-2%. These are the highest wage earners who pump the biggest percentage of cash into our overall economy. Having them fully employed is keeping our economy burning.
Overall, with these other mitigating factors even if we had $100 a barrel oil today the shock would not be as severe to our economy as $38 oil was in 1979. But as you can see from the chart we are getting closer but still aren't at $100/barrel Oil average monthly price.
How Did we get here?
From 1946 until the early 1970's the nominal price of oil remained basically flat but the inflation adjusted price of Oil actually declined slightly.
The tremendous spike in the 1970's resulted from the Arab Oil embargo and OPEC taking control of Oil prices. Prior to that the US government had forced US producers to produce oil at controlled prices so U.S. production had declined and more and more oil had come from overseas. This is what eventually resulted in OPEC gaining enough power over our supply to allow the embargo to have any teeth. Whenever prices are artificially held back it works like a stretched slingshot, eventually when it is released it will explode in an effort to return to the free market price causing major disruptions in the process.
As the oil price adjusted to true market pricing it spiked up and has been floating freely ever since.
Recently, forces have converged to create a similar situation. But this time it is a transportation/refinery shortage problem.
Remember the Exxon Valdez (the ship that crashed off the coast of Alaska) which spilled millions of barrels of oil all over the coast? Well believe it or not, that was the beginning of our current problem. Because of that accident and a couple of others like it, governments around the world began outlawing single hulled tankers.
This created a shortage of double hulled tankers. And double hulled tankers are very expensive to build and weren't very profitable with oil at $20/ barrel. So there was no rush to build them (plus they aren't built in a day even if there was a rush!)
In addition to not enough tankers, there aren't enough pipelines or refineries either. Who wants a pipeline or refinery in their backyard?
So we are caught in a crunch between inadequate transportation, maxed out production and an increase in demand for oil. Because the US and China are both coming out of a recession both countries are also demanding vast increases in oil.
Chart courtesy of InflationData.com see Inflation Adjusted Oil Price Chart article for more information.
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