- Economic analysis depends on historic data. Oil prices increase direct costs like increased heating and gasoline expenses, indirect costs from higher prices for goods and services, and wage inflation. The cycle takes 3 to 4 years before economists can conclude the cyclical impact.
- Forecasts can be short sighted. For example, this 2000 study concluded:
In summary, the reduced utilization of petroleum in the U.S. and Michigan economies in the past 20 years makes us less vulnerable to economic disruptions due to increases in crude oil and petroleum product prices. However, the recent price increases have been significant and, while they are not expected to cause a severe impact on the economy as a whole, the impact on low-income households can be crucial.
- The estimated multiplier is 2x the percentage of household income spent on fuels.
- When prices increase dramatically, the multiplier may not be linear. Linear forecast is the normal extrapolation from data-constrained economists.
- Slow, inaccurate economic analysis contribute to the Energy Independence problem.
 | Oil Price Increases Impact Economy Michigan Public Service Commission | |
The sharp increase in crude oil and petroleum product prices since the spring of 1999 have had little impact on the national and Michigan economies. After falling to about $10 a barrel a year ago, crude oil prices reached $30 a barrel in January and February 2000. During the four years of the 1979-1982 recession, the average cost of crude oil was more than $28 a barrel, and the impact of high oil prices had a devastating impact, triggering the worse recession since the Great Depression. Analysis suggests:
The U.S. Experience 1979-1983 |
Prior to the 1970s, the world's petroleum prices were largely controlled by the Texas Railroad Commission. In 1973, the Organization of Petroleum Exporting Countries (OPEC) began to assume a major influence on oil prices. Impacts are clearly seen in Figure 1, which shows crude oil prices from 1967-1998. OPEC, founded in 1960 by five leading oil producers including Saudi Arabia, had previously not attempted to influence oil prices. OPEC had originated to help coordinate its members' petroleum policies and safeguard their interests. In 1970, its members each agreed to set an oil export tax rate of 55 percent. Then, in 1971, OPEC members began to nationalize the oil industry by |  | |
negotiating its transfer from the oil companies that had previously negotiated rights to the oil. The Arab-Israeli War in 1973 and the U.S. support of Israel contributed to causing the first significant oil price increase by OPEC. In October 1973, Arab members of OPEC declared an embargo on exports to the U.S. As a result, crude oil prices increased from an average of $4.15 per barrel in 1973 to $9.07 in 1974, and this price increase led to the U.S. recession in 1974. In the late 1970 s, political unrest in the Mid-East created conditions for the dramatic oil price increases of 1979-1981. The government under of the Shah of Iran, supported by the U.S., was the center of turmoil. When anti-west Islamic fundamentalists gained control of the country during the Iranian Revolution, Iranian oil production declined dramatically, leading to huge price increases. U.S. crude oil prices increased from $12.46 per barrel in 1978 to $35.24 in 1981. Once again, oil price increases put the U.S. and other industrial economies into a recession, this time the worst recession since the Great Depression. Inflation skyrocketed, peaking at 13.5 percent in 1980 and averaging 10.3 percent in the 1979-82 period. Recent Oil Price Developments The cost of crude oil for U.S. refiners was just over $20 in 1996. Prices dropped slightly in 1997 and then fell to just $12.04 per barrel in 1998. For the first two months of 1999, the acquisition cost for crude fell again – to $10.50 a barrel. In these years, countries around the world benefitted from the lower costs of virtually all petroleum products. In early 1999, most petroleum analysts viewed oil prices as artificially low, and the resulting low prices cut revenues to oil exporting countries. To address this situation, OPEC met in March 1999 and agreed to cut production, with a goal of increasing crude prices to around or just above $20 per barrel. Although compliance to previous OPEC agreements had been difficult to maintain, adherence to this agreement has generally been good. Crude oil prices rose immediately, to $15 in April and to above $21 per barrel (U.S. refiner cost) by September 1999. OPEC met again in September 1999 and agreed to maintain the production cuts through March 2000. The production cuts combined with persistent world economic growth pushed crude oil prices up, to above $24 in December. In early January 2000, Saudi Arabia indicated OPEC's resolve to stick to the production cuts through March, in spite of declining world crude oil and product inventories. Prices continued up, hitting $30 per barrel in January and again in February 2000, compared to $10.25 one year earlier. Indications from OPEC members in late February now suggest that production will be stepped up when OPEC next meets in March; some indications suggest that production has already started to increase. It is clearly in OPEC's interest to maintain market stability without harming the world's economy. Why the Little Apparent Economic Impact of Recent Oil Price Increases? So far the U.S. and Michigan economies haven't reacted to the recent petroleum price increases. Is the impact yet to come? Perhaps the impact won't occur until the price sticks for a time at some threshold price, maybe $35 or $40 dollars per barrel? | ||
Figure 2 shows the impact of adjusting crude oil prices for inflation. The inflation-adjusted prices are in 1999 dollars. The figure shows the 1981 year's actual price of $35 adjusts to $60 dollars a barrel in today's dollars. This suggests that, in real terms, oil prices would have to reach $60 per barrel today to match the 1981 price and the resulting impacts. Note too that once adjusted for inflation, today's oil prices are almost as low as those in the late 1960s. Efficiency improvements and the use of other energy sources, such as natural gas and electricity, have also lessened the dependence of the U.S. economy on oil. |   | |
 | Figure 3 shows the improved performance of the U.S. economy based on per barrel of oil consumed. In the 1970s, the economy generated about $250,000 of national output based on per barrel of oil consumed. Now the economy produces over $450,000 per barrel, an 80 percent improvement. Figure 4 shows crude oil expenditures as a percent of Gross Domestic Product (GDP). The graph essentially reflects the combined effects of inflation and the decreased reliance on oil. As the figure shows, the U.S. economy spent more than 6 percent of GDP on crude oil in | |
1980 and 1981, when crude oil averaged $28 a barrel. In 1996-97, crude oil averaged $20 per barrel, 28 percent less than in 1980-81. However, the percent of GDP spent on crude oil is less than 2 percent and was just 1 percent in 1998, compared to more than 6 percent in 1980-81. This indicates that rising oil prices are less capable now of affecting the economy than they did in 1980. (Crude oil expenditures represent about one-half the retail costs of petroleum products.) Additionally, Figure 4 shows two hypothetical oil price projections for the year 2000, at $20 and $40 per barrel. The $40 per barrel price (not a projection, and set for illustration only) would yield U.S. crude oil expenditures only 3 percent of the GDP. While such an increase might slow the current economic expansion, the impact of $40 oil on the present economy would be less than in any of the 11 years during 1974-1985 and less than one-half the impact of 1980-81. Price Impacts Michigan and the nation are impacted by higher oil prices by direct, indirect, and induced economic multiplier effects. Direct impacts are the increased expenses for purchased oil or oil products. Indirect impacts include the changed prices paid for other products and services, which pass along the higher fuel costs in the product prices. Last are the induced impacts of price increases. The initial direct and indirect impacts cause consumer prices to rise, and this feeds through to wage increases, which raises labor costs, which, in turn, raises the prices of products and services. The U.S. General Accounting Office (GAO) in "The Prospects for Economic Recovery," February 1982, concluded that the increase in oil prices directly and indirectly caused most of the high inflation in the 1979-1981 period. For consumer prices, the GAO looked at the direct increases in expenses for consumers for gasoline, fuel oil, etc. and the indirect costs of higher prices for other goods and services. Figure 4 captures in a simple way the direct and indirect impacts to consumers. This figure shows that crude oil expenses rose from about 4 percent of GDP in 1978 to 6.5 percent in 1981. This 2.5 percent increase passes through to households directly in gasoline and heating fuel costs, and indirectly in higher prices of goods and services, which roll in their higher input (fuel) costs. The total direct and indirect impacts are approximately the full 2.5 percent change in total economy costs resulting from the crude oil price increase. This created another round of price increases. In the 1979-82 period, many wage contracts had automatic price escalators (consumer price indices). Assuming 80 percent of wages and salaries increased to offset the 2.5 percent increase in consumer costs, the total wage bill for the economy would rise 2.0 percent (2.5 x .80), and this would again raise prices for consumers. The impact was repetitious in the 1979-82 period, leading to final consumer price impacts which were more than double the initial 2.5 percent impact. These are the induced impacts of the initial price increase. Today, the induced effects are almost negligible because wage contracts are not typically tied to a price escalator as they were in 1980. Therefore, a petroleum price increase this year would be absorbed into consumer budgets with virtually no (or a very small) step up in labor costs. Breaking the firm link between increasing consumer costs in wage agreements has served to mitigate the economic multiplier impact of price increases.
| ||
Michigan Oil Expenditures Trend Figure 5 shows embedded crude oil expenditures for Michigan as a percent of Michigan's Gross State Product (GSP). These expenditures are much less than the actual retail costs of Michigan businesses and households for petroleum products, which also include refining costs, wholesale and retail markups, and taxes. For instance, in Figure 5 the year 1990 falls exactly at 2 percent, representing crude costs |  | |
of $3.76 billion. But, the actual Michigan costs for petroleum products in 1990 were $7.2 billion, or 3.86 percent of the GSP. Again, as a rule of thumb, the total retail costs are about double the crude petroleum costs shown on the graph. Michigan consumes less petroleum products per unit of output than the nation, as seen by comparing Figure 5 with Figure 4. In 1981-82, Michigan's petroleum expenditures peaked at less than 5 percent of GSP, compared to more than 6 percent nationally. Michigan's lower reliance on petroleum is due to the wide-spread availability of natural gas in Michigan. Michigan would see less direct impacts of continued high oil prices than the nation, given the relatively lesser amount of petroleum fuel used in Michigan. However, the indirect and induced price impacts would be similar in Michigan as for the U.S. Indirect impacts would be based on the consumption of all goods and services, not just Michigan products. The induced impacts would be similar to national impacts, since wage agreements in Michigan would typically use a national price index rather than a local index. However, as noted above, wage increases are not as closely linked to consumer prices as they were in the past, and this would serve to mitigate the negative economic multiplier impacts on inflation. Michigan Household Impacts Although the aggregate economic impact of changing oil prices has greatly diminished, changes in the prices of petroleum products are significant for Michigan households. The average Michigan household consumes 1,006 gallons of gasoline per year. The abundant natural gas supply and an extensive pipeline network have reduced the number of homes heating with fuel oil since the | ||
| mid-1970s. Michigan's household consumption of fuel oil has declined from 800 million gallons annually in the mid-1970s to 165 million gallons currently. Seventy-seven percent of Michigan homes now heat with natural gas. There are 236,300 fuel oil-heated homes and 207,300 propane-heated homes in Michigan, comprising 7 percent and 6 percent of Michigan homes, respectively. |  | |
Since January 1999, Michigan gasoline costs are up more than $400 per household at either current or year 2000 projected prices, as shown on the immediate graph. Fuel oil costs are up over $200 annually and propane costs are $300 higher. Households that heat with either fuel oil or propane | ||
will see fuel cost increases of $600 to $700 a year, compared to last year. On a monthly basis, the impact is greatest in winter months (an increase of approximately $100 a month during the heating season) and does not reflect any changes in bills due to changing weather conditions. Obviously, these additional costs cannot be avoided by most households and are significant for households on tight budgets. Also, the cost increases cut discretionary spending and may contribute to wage inflation pressures. |  | |
  |
Longer-term actual and inflation-adjusted fuel prices for Michigan households are shown in the adjacent graphs above. After adjusting for inflation, current prices are still relatively low. Inflation-adjusted prices, shown in 1999 dollars, have been falling since the early 1980s and are not much higher now than before the oil embargo of 1973. Michigan's average gasoline price peaked in real terms in 1979 at $2.92 ($1.27 actual), compared to the current price of $1.50 per gallon (AAA Michigan, February 21, 2000). The real price of heating oil and propane also peaked in 1979 at $2.11 ($1.15 actual) and $1.46 ($0.64 actual) per gallon, respectively. As of February 21, 2000, the average Michigan prices of fuel oil and propane were $1.19 and $1.20, respectively. In summary, the reduced utilization of petroleum in the U.S. and Michigan economies in the past 20 years makes us less vulnerable to economic disruptions due to increases in crude oil and petroleum product prices. However, the recent price increases have been significant and, while they are not expected to cause a severe impact on the economy as a whole, the impact on low-income households can be crucial. | ||
| Prepared by the Statistical Analysis Section, Executive Secretary Division, MPSC, March 3, 2000 |
Posts
No comments:
Post a Comment