The oil shock of 2008

Time to reassess the potential for recent oil price increases to contribute to an economic downturn.

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:

How do the challenges this poses for domestic automakers compare 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.

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42 thoughts on “The oil shock of 2008

  1. GSS

    Wasn’t there a housing recession in 1990, too, in addition to the oil issues? Very useful stuff, thanks.

  2. Menzie Chinn

    Another contractionary impulse from the rise in energy prices comes from the demand side. Oil imports were 3.17% of GDP in 2008Q1; this ratio has only been exceeded once — in 1980Q1 — when it hit 3.22%. So while the energy intensity of GDP is lower — a factor on the supply side — the leakage out on the demand side is pretty substantial.

  3. DickF

    US Oil production in the 1960 and early 1970s before the dollar was floated was over 3 times what it is today with about the same known reserves. It is not a surprise that oil imports are increasing. While the mantra from congress is that we cannot produce our way out of this problem with the price (which I agree with looking at the inflation numbers) it is clear from the statistics that Congress is doing nothing to help. Domestic reserves are high but production is down and that is a direct result of government regulation. Once again central planning proves is power to destroy.

  4. Menzie Chinn

    DickF: I should have been more specific in my comment: the nominal value of oil imports as a share of nominal GDP has risen to 1980Q1 levels. The quantity of oil imports declined from 1978 to 1983. It has again been trending downward since about mid-2006.

  5. Silas Barta (formerly Person)

    So, where’s the surge in used fuel efficient Sentras and collapse in the price of less fuel-efficient new full-size sedans?
    Oh wait, I forgot, logical things don’t happen if they would benefit me.

  6. phil macnutt

    the last chart says that SUV sales are “crashing”. i guess i am reading the chart wrong because it looks to me like they are UP from January.

  7. Anonymous

    Prof Hamilton
    Great post. I would like to point out that the demand for oil not only depends on the price, but also the other factors that go into determining the demand curve. We could shift the demand curve to the left by eliminating the effective subsidies to automobile use that currently exist. Parking at work is currently subsidized for 80% of workers by the tax code that allows employers to deduct the cost of providing workers with “free” parking. Eliminating this, or at least requiring employers to pay non-driving workers the cash equivalent of the “free” parking benefit, would reduce the subsidy people enjoy when they drive alone to work. Where “parking cash out” has been implemented, about 15% of commuters stop driving alone and find other ways to get to work voluntarily, pocketing the benefit.

    Similarly, the current auto insurance system constitutes a subsidy to high-mileage drivers from low-mileage drivers. The current “unlimited miles per year” system creates an incentive for all drivers to drive more than they would otherwise, since the marginal insurance cost is zero. Moving to a “per-mile” basis for determining insurance rates would eliminate this perverse incentive. Low-mileage drivers would benefit directly and immediately with lower rates, and all drivers would stand to save as they drove less and would adjust their behavior accordingly. Less driving would shift the demand curve for gasoline to the left, causing the price to fall, other factors remaining constant. See Aaron Edelman of UC Berkeley on the logic of per-mile auto insurance.

    Happy Trails
    Green Marketeer

  8. Joshua Zucker

    @phil macnutt: take a look at the numbers EVERY year, where April is always higher than January in sales. Factor out that effect if you want to say whether sales in April are higher or lower than January. More to the point, look at sales compared with the last several years …

  9. Lucas

    phil macnutt: Sales are barely up from January 2008 to May 2008, but it’s reasonable to suppose that that’s mostly because people buy more vehicles during warm weather. For any given month in 2008, light truck sales have plunged compared to the same month in previous years.

  10. Lilguy

    An invaluable analysis in providing perspective on where the oil problem is now (very bad) versus the last half century. Everyone should read this, but I doubt we’ll see it in the NYT, WSJ, WashPost, etc.
    Thank you for the work.

  11. PainInThePump

    Thanks for putting this together.
    The reality is the price of oil today makes absolutly no economic sense from a historical perspective.
    Still there is a very interesting alaysis that was done that indicated that one of the big problems, not just with oil but many other commodiites as well, is that since 2003 investment into Exchange Traded (commodity)Funds in oil has increased from $13B in 2003 to over $260B in 2007.
    The problem is what these funds represent- only the buy side. Typically in commodities you have a willing buyer and seller at a set price. However, today what you have is a portion of the segment that is typing the scales to “just the buy side”. This creates an exponetial or compounded affect on the market because it drives one side out of balance with the other.
    The truth is there are about 5 guys sitting in Greenwich, Con getting extremly rich off the pain of this country. And here is another problem, to bet a $1 million in the oil futures market they only need to risk $100,000 or just 10% of the contract. These margin requirements ,must be raised to at least 50%.
    If these two affects on the market are neutralized then oil will drop to $65.00.

  12. PainInThePump

    Here is another reality- independent truckers are parking their trucks. The reality is they are not able to pass along the diesel prices. It is very hard to get a truck, independent truck, to haul goods today.

  13. DickF

    My comment was not directed to you but just a general comment. I think I understand your point about imports and do not disagree. Thanks.

  14. DickF

    The reason that the price of gasoline is so difficult is because the inflation has not passed through the system. Most of us are still living on wages based on the 2000 money supply while oil is being sold on the 2008 money supply.

  15. clint

    FT has a good overview:
    Act now to prick the oil price bubble
    By Meghnad Desai
    Published: June 5 2008 19:21 | Last updated: June 5 2008 19:21
    Between February and May of this year the oil price went from below $90 to $128 a barrel, a monthly growth of 9 per cent. If the rise continued at this rate, it would mean an unprecedented doubling in price every eight months. In recent days, after the price briefly touched a high of $135, there has been a bout of profit-taking. Although the price has now fallen it has not yet dropped much below $125.
    The latest price rise has baffled many. What has happened to supply and demand to cause such a steep and sudden price rise? Gordon Brown, the UK prime minister, said last week that the cause is clear: growing demand and too little supply. China and India are buying more oil. Costs of exploration and extraction are going up. Nigeria and Venezuela are causing anxieties about supply. But these factors are not new. Nothing has happened in the real oil economy to justify such a sharp and steep rise in its price.
    There is a growing feeling that the latest sharp upsurge in the price of oil may be a speculative bubble rather than an outcome of market fundamentals. The US Commodity Futures Trading Commission indicated last week that there may be system risk and George Soros, the veteran investor, in testimony on Capitol Hill on Tuesday, warned that commodity index funds, which treat oil as an asset rather than a commodity to be bought and sold for use, are creating a bubble.
    Bubbles come to an end eventually but there is no guarantee that this will happen soon. The global economy is likely to be forced into a serious crisis if we do not explore the possibility that this is a bubble that needs to be burst quickly. The market can then resume its trend, depending on whatever the fundamentals dictate.
    Much of the rise in oil price is the result of activity on the New York Mercantile Exchange, the energy exchange. This is activity by index funds and pension funds that are investing in oil futures, not for direct use but as financial assets for profit. That contrasts with activity by oil producers and consumers who buy and sell to smooth out fluctuations in price and delivery.
    These financial institutions index funds and pension funds are neither buying oil nor selling it. They are passive investors in commodities. They have invested $260bn (169bn, 133bn) in commodity markets, compared with $13bn just five years ago. Much of this money is in oil. The Goldman Sachs Commodity Index is heavily weighted by oil 78 per cent compared with less than 2 per cent for precious metals.
    The point is that this paper market is not driven by the pressures on demand and supply but entirely by price expectations. An underlying situation which may well indicate a medium-run rise in oil price is being exacerbated by the bolstering of expectations that prices will rise even faster. It is this extra layer of price rise that is driving money into even the farther future contracts. There are futures contracts being bought and sold for 2016 at $138 only astrologers pretend that they can forecast that far ahead.
    How large is the speculator activity? The total open interest the number of open or outstanding contracts for which an individual is obliged to the exchange because that individual has not yet made an actual contract delivery in the 2008 contracts on May 21 was 849.472 contracts, which equals 849m barrels, or nearly 10 times the daily crude oil production. The daily volume in the 2008 contracts on May 21 was 657.391 contracts, equivalent to 657m barrels or nearly 8 times the daily crude oil production.
    This is a problem that requires immediate action. The best way to counter speculation is to make it less profitable. Step one is to protect the regular traders in the real oil economy (those who intend to close their positions by making or taking delivery of oil) and charge them a lower margin than those who have no intention of plying the oil trade. The purely financial traders must be made to pay a proper price for their speculation. This can be done simply by increasing the margin that they have to put down to trade as open interest, from the current 7 per cent to about 50 per cent.
    It is up to the Group of Eight leading industrialised nations leaders to urge Nymex to implement this policy. It is in tune with free market logic and at the same time it makes oil speculation less profitable. There is no need for western governments to go down on their knees to Arab oil sheikhs, or to ration oil to the increasingly cash-strapped and angry consumers.
    Lord Desai is emeritus professor of economics at the London School of Economics and a Labour peer

  16. Jeffrey Todd Brown

    It’s all about corruption and greed and war. Oil prices have increased %100 in the last year. However, on average oil company and oil service company profits have increased %400. Furthermore, the major oil companies own subsidiary companies that overcharge for transportation of oil and deduct those charges from the royalties they are supposed to pay the govt. or owners of the mineral and oil and gas right. Furthermore, the use of all the fuel for unjust and lied about “wars” depress the domestic supply. The energy boys and Bush/Cheney have rigged the regulations and allowed the oil companies to charge sky high prices when this happens, even though there are no shortages. It’s racketeering directly from the White House and Congress. Even the Democrats get rich from it. Then the speculation begins in the Markets and make things even worse. But the bottom line is, it is CORRUPTION, and the most powerful, and most wealthy folks in the world are using all of the normal folks (people that make less than millions of dollars a year) as grist for their mill. They don’t care about us, they care about power and dominance and greed. This is all a class issue, especially when you consider that the huge majority of this oil is extracted from the public domain (public lands) for very little payment. The ultra-rich of all the countries are beginning to put the screws to the other 99.99 percent, and are beginning to tighten the noose on the average guy on a worldwide basis. Our wars are fought to provide stability for their vision of the future. The royalty of each country are beginning to work in concert with the wealthy of other countries to supress the masses in general. Welcome to your new world order.

  17. Michael Roberts

    It might help to consider energy costs besides oil.
    Coal and natural gas prices normally move in the same direction as oil prices. Although, today prices for natural gas only went up a small fraction of oils’ increase, coal prices have generally increased a lot. And with price freezes in China, that could put more upward pressure on prices worldwide.
    I don’t think it would take much effort to find a good approximation for energy expenditures as share of US GDP, not just oil. I’m too lazy and busy to do that on my own right now, but I expect it is getting pretty high…

  18. GK

    Yes, oil prices are the reason for the current recession, and the adjustment will cause mild to moderate pain.
    But don’t ignore the positive side effects over the medium and long term :
    1) Less driving = less traffic accidents. Traffic accidents in the US cause $500B in damage, 2 million injuries, and 40,000 fatalities a year (mostly children and young adults). A 10% reduction in driving and migration to smaller, lighter cars will reduce this number.
    2) Automakers are rapidly innovating in MULTIPLE areas, including
    a) alternative fuels (electricity, ethanol, etc.)
    b) more efficient engines
    c) lighter nanomaterials that greatly reduce the weight of cars.
    3) Less driving reduces wear and tear on roads (which are very expensive to repair), reduces traffic (that wastes tons of productivity), and reduces competition for parking.
    4) If 10% of the land consumed by parking lots and gas stations reduces, that frees up a LOT of land for other uses. Think about how much land that is.
    5) Of course, less oil consumption means less pollution.
    6) Technologies like videoconferencing, Skype, Webex, etc. accelerate. Telecommuting will increase, as corporations adapt to accomodate this.
    7) Iran, Venezuela, etc. subsidize gasoline. As oil prices rise, this becomes more costly, even as their domestic consumption rises. Thus, the barrels they can export shrink, and the dollars of export revenue they get actually shrink. This will cause these brutal regimes to burn the candle at both ends, and collapse eventually.
    So I think the short-term negatives are more than exceeded by medium and long-term positives, just like the last oil spikes.
    Quit whining and adapt. Invest in areas likely to benefit.

  19. Datamunger

    Prof Hamilton,
    For a more accurate (though less timely) measure of gasoline consumption, the monthly EIA figures are superior. They are not estimates but an attempt to account for all gasoline consumption. The weekly estimates often turn out to be off by 1% or more in comparison to the monthly figures which are released much later. Yet the weekly data is never revised.
    Using the monthly data which is available up to March, gasoline consumption has fallen 1.3%.
    According to monthly data crude oil consumption has fallen about 4.5%.
    In fact, February and March were the first back to back months with consumption below 20 million barrels per day since 2003.

  20. Datamunger

    Should have added that the declines in gas and crude oil consumption I cited above refer to Jan-March ’08 in comparison with the same period in’07. (Remember 08 is a leap year).

  21. Sandman

    Oil going up is a good thing as the global liquidity machine is still turning.
    If he had done what classical theory says: let it all plop, the economy would be MUCH worse right now.
    Devalue the dollar and we will be ok.

  22. dave

    If oil prices exceed $150/BO, the US economy
    will suffer huge economic shock!
    Note: $153/BO = [14 trillion*.08/7.3B]
    The US can’t sustain oil prices equal to or gt 8% of its gdp.

  23. Imethisguy

    Just a quick note about new supply (or lack of) from someone toiling in the oil fields:
    If there were to be new supply coming on in the summer of ’07 through spring of ’08, it would have had to be explored for and (with hope, skill and luck) found ten years ago (give or take). Have a look at the first graph and the price ten years ago: near the lowest price in history, and trending down down.
    It would have had to have been a brave explorationist who put his/her personal or company’s $$$ on the line ten years ago in an environment like that.

  24. algernon

    Jeffrey Todd Brown
    If you believe that crap you wrote, you ought to buy some shares Exxons or Transocean (which are for sale to everybody every day). Give those profits, which you seem to assume are guaranteed by corruption, to charity to counter the ‘greed.’

  25. Lennart

    Tnx, for a very good article.
    It gave me the answers on some questions I have wondered about recently.

  26. Anonymous

    The conspiracy continues. Every $10/bbl sucks $80 billiom $’s out of our economy. Food from our familites. Why aren’t we energy independent. ASk your friendly politician. Obmaa Muhamad will not solve this………….

  27. Donal

    GK, Interesting points, but many people are switching to motorcycles and scooters, and not even using helmets. New cyclists won’t realize that car and truck drivers won’t always see them. Expect fatalities from collisions between inexperienced cyclists and heavier vehicles.

  28. Sebastian

    JH said: “Time to reassess the potential for recent oil price increases to contribute to an economic downturn.
    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….
    What say you to the argument that current conditions in other areas of the economy aren’t the same as in the years you mention, so it’s not reasonable to expect the impact of high oil and gasoline prices to be the same, i.e., inflationary and recessionary?
    In ’73-’74 U.S. capacity utilization was above the 85% range that’s considered problemmatically inflationary. In 1978 it rose back above 85% again. At the outset of the 1980 recession it was up around 84%.
    As of the most-recent reading it was just below 80%, a non-inflationary level.
    Nobody *likes* higher energy prices, but how *damaging* are they in real economic terms (as opposed to consumer outrage) to the present-day economy as opposed to previous oil spikes?

  29. Guy Fox in Key West

    When chaos and anarchy starts here in Flori-duh (the land of Flamingos, Footballing fanatics, Flim-flam $cams and Voter Fraud), I shall take a boat or a raft or anything that floats and try to get to Cuba… as many other Amerikans will also be doing. Cuba has been $urviving peak oil since 1960… so they know how to handle the peak oil crisis, a terrible crisis that is coming to Amerika, a land of clueless fat people. Behold! See their leader (George W. Bush), a naked emperor, a dry drunk $ociopath. See Bush ride his little cowboy bicycle around the Texass ranch while Rome burns!

  30. Robert Sczech

    One interesting effect of rising oil prices is that it shows the true strength of all economies in the world. In England, friends tell me, one gallon of gas sells for $10 while in Germany the same gallon sells for $9. The difference to the US is of course the higher level of taxation. Nevertheless, if these economies do not collapse at $10 gas, then perhaps the US will not collapse at $10 gas either. However, if demand for oil starts to exceed supply, eventually some of the major economies will have to fold. It will be interesting to watch which if the G7 economies will fold first.

  31. GK

    Actually, the Petrotyrannies will be the ones to fold, not the G7, even though they are profiting the most now. They are burning the candle at both ends by using export dollars to bribe the public with 12 cent/gallon gasoline, which increases domestic consumption and shrinks export barrels.
    Read why here.

  32. Marty


    I recently moved from San Diego to London. People drive less here. UK/EU cities (and countries) are more compact. Public transportation is heavily used, and by people from a wider socioeconomic band (UK/EU trains mainly move people, US trains mainly move freight). Per capita energy use is approximately one-half as much as in the US.

    The US economy won’t collapse with a doubling of oil prices. But people’s habits will have to change. It seems to me that the biggest problem is that oil prices can change faster than infrastructure can respond. One advantage of higher taxation is that it made it possible to develop the necessary infrastructure at a more leisurely rate.

  33. asagefield

    Thanks for the article – very nice. You touched upon some major points and did a nice comparison to other time periods.
    I would also add:
    1) The idea of Peak Oil is sinking in…and it is tethered to emerging market growth. This accelerates the process. So instead of have a graph that looks bell shaped. It might end up looking a bit lopped off on the right side.
    2) Greening policies in developed countries to reduce emissions and increase fuel efficiency. This i)adds pressures on other commodities (metals, corn) in development of technologies and alternatives to meet that; ii) increases costs throughout the production chain of most commodities tying them into oil’s rise.
    3) Geopolitical instability is a REAL ISSUE now for a couple reasons. The middle east has a power vacuum where there once was a nation called Iraq. Add to that Iran’s “platonic” nuclear build up…it’s something to think about.

  34. Bill Pinoy V.

    Slowly but surely we now realize oil is finite and its availability in decline. WE CAN MAKE A SUPER EFFICIENT 4 CYL 2.5 LTR ENGINE THAT RIVALS MOST 6CYL ENGINES, BUT THOSE MOTOR COMPANIES WON’T BECOUSE THE PROFIT IN 4 CYL ENGINES IS LESS.

  35. The American Mind

    Economics Links–06.09.08

    Eyes will be on the dollar going into high-level G8 finance meetings this week.
    In not the clearest prose (he is a central banker) Timothy Geithner calls for streamlined financial regulation, greater capital cushions for banks, and the development of …

  36. STS

    GE selling their Plastics business — the powerhouse division that was a path to the top for GE leadership including Immelt himself — to the Saudi’s (SABIC) is very instructive.
    1. GE obviously doesn’t think the price of oil is going down anytime soon. At least not enough to restore eroding profit margins in that business. Some will argue that is because GE is “green addled”, but this is a pretty serious bet not just fluffy PR.
    2. Saudi Arabia is making a smart move *up* the value chain. Many in the west have been inclined to assume that the middle east is totally “inebriated” by their oil — distracted from making sound investments in a less oil-intensive future. Granted plastics is not a big *diversification* move, but it is at least a step towards ownership of the value chain above the pure commodity level.

  37. richard

    If gas at the pump prices rise in the USA they will still be below Europe before the 2008 price rises. High oil prices are a time for innovation not moaning. Invention is the mother on necessity and all that. Are we getting back to the 1970s when the high energy prices started the alternative energy movement? I think it was then that people started making their own energy devices again – wind, solar and biomass. The innovation was wonderful. Too often we see high priced products that just won?t pay and are difficult to maintain. (In my opinion sustainable living is not just about buying an expensive piece of equipment off of the shelf?.but then again anything that helps is welcome. )With a low cost DIY project you can get the energy you need at a low cots, recycle parts around you, and have some great fun too

  38. David Austin

    A quick reply to a comment by Menzie Chinn (“where’s the surge in used fuel efficient Sentras and collapse in the price of less fuel-efficient new full-size sedans?”)…
    I think the prices of full-sized sedans are being supported by the migration of would-be truck buyers into cars (large cars being the closest car substitute for a light truck) in response to higher gasoline prices. And though there has not been a *surge*, exactly, in the prices of used Sentras (I think that is what you are referring to), their prices are trending up, month by month (admittedly, all I have seen on this is average wholesale price for that type of car, not controlling for age or quality. But still.)
    I’ve enjoyed looking at all the material on this blog today!

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