How Oil Could Kill the Recovery

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There are plenty of reasons to be optimistic about the U.S. economy. Workers are earning more, consumers are spending more, banks are lending more, and companies are ready to hire more. But if there's one number that could derail the recovery, it's the price of a barrel of oil.

Economists and watchdog groups are nervously monitoring the rising price of crude, now hovering around $90 -- down from a 2008 high of nearly $150. "Oil prices are entering a dangerous zone for the global economy," warns Fatih Birol, chief economist of the International Energy Agency. "High oil prices threaten to derail the fragile economic recovery," echoes Sylvia Pfeiffer at the Financial Times. Meanwhile, other economists say there's very little reason to think oil should spook the fragile recovery.

Who should we believe, and why should we care in the first place?

WHY SHOULD YOU CARE?

The short answer is that expensive oil is poisonous to an oil-driven economy. Every severe oil spike in the last 50 years has been followed by a deep recession.

Here's the more complicated answer. The United States imported $400 billion of oil in 2008, nearly 3 percent of GDP -- or more than half the total cost of Social Security. Unlike Social Security, those hundreds of billions of dollars leave the country and don't get recycled into our economy. They're empty calories.

"If oil prices went back to the $140 dollar range, it would be a disaster"

When gas prices rise, American consumers can buy the same amount of gas for more money, which makes us poorer; or they can buy less gas, which makes the economy weaker. In the last decade, the price of crude increased from $1.50 to $3.50, and Americans kept filling up their SUVs. Only at $4.00 did Americans recoil, reducing their total miles driven fell for the first time in 30 years by 100 billion miles.

Some economists say the oil spike helped cause the Great Recession. By making it more expensive to commute, they argue, high oil prices both made Americans poorer and reduced the demand for suburban homes, thus hastening the housing collapse. A less dramatic interpretation would say that the Great Recession was caused by the credit crunch on Wall Street, but exacerbated by the historic rise in oil prices.

global oil demand.pngIn the Great Recession, the price of a barrel of oil fell by almost 70 percent. But now oil prices are climbing, for at least three reasons. First, higher global demand raises the price of oil if global supply cannot keep up. Second, as capital becomes more available throughout the world, investors might return to bidding up the price of oil. In 2008, experts estimate that up to a third of the $150 price of a barrel of oil was pure speculation rather than natural supply and demand factors. Third, in the U.S., a weak dollar makes oil, like most imports, more expensive for consumers. So what happens now?

THE CASE FOR FEAR

If you thought $4 gasoline was bad, wait a year. Americans will pay $5 for a gallon of gasoline by 2012 as global demand grows faster than oil producers' supply, predicted John Hofmeister, the former president of Shell Oil and current head of Citizens for Affordable Energy. Without a significant investment in alternative energy sources, we're on a collision course with "blackouts, brownouts, gas lines, [and] rationing."

Hofmeister's math can be summed up in one graph, from the Center for American Progress, which shows projected oil consumption for the U.S., China and India. As China and India join the global middle class, global demand for oil will skyrocket past its 2008 levels, when a barrel cost $147.


Insatiable global demand for oil isn't the only thing that could push up prices. A coup in one of the many unstable oil-producing countries could produce a supply shock. A more likely culprit would be speculation. In 2008, investors with a glut of capital placed their money on commodity futures, driving up the price of oil. As the economy recovers, those investors might return to their old habit -- especially if inflation starts to pick up in the U.S. and investors look to oil as a hedge.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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