How Oil Could Kill the Recovery

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.

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.

In 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.

Any of these scenarios are enough keep economists awake at night. "If oil prices went back to the $140 dollar range, it would be a disaster," said Daniel Weiss a research fellow at CAP, "because oil spikes almost always produce economic recessions."

THE CASE FOR CALM

"I'm not too worried about oil crippling a comeback this year," said Christopher Steiner, author of $20 Per Gallon. "There are a lot of reasons why we shouldn't expect oil to go much over $100 per barrel."

First, he cited greater supply. OPEC is producing more oil and has healthier inventories than in 2008. Second, he cited lower demand. The United States, Europe and Japan are all importing significantly less oil than we did when prices passed $140 a barrel.

"In the next few years, if we're still recovering, and China and India join the global middle class, then eventually we'll probably hit $5 gas," Steiner said. "But overall, I think 2011 will be pretty boring on the oil market. The memories of 2008 are too fresh, and nobody wants a repeat."

That includes OPEC. Extreme oil prices are obviously bad for importers, but they're also bad for exporters. Oil producers like Saudi Arabia want oil expensive enough to mint healthy revenue, but cheap enough to keep the world's consumers from fleeing to alternative sources of energy.

"The Saudis believe their ideal price is $80 a barrel," Weiss said, "because that's the price point where they can make lots of money but not spur conservation efforts."

Weiss, an advocate for developing clean alternatives to oil, acknowledged that even if alternative technologies don't come on line in the next few years, the president has ways to fight an oil spike. For example, without congressional approval he could sell oil from the Strategic Petroleum Reserve, which is now at 100% capacity with 726 million barrels, to cushion the blow for families if oil prices spike.

WHAT SHOULD WE WANT

Oil blots our economic outlook. To get the export-driven recovery White House economists want, we need two ingredients: a weaker dollar to make our goods cheap and strong foreign consumers to buy our stuff. Ironically, a weak dollar and strong global demand would also conspire to make gasoline more expensive. In fact, if you wanted to design a scenario where oil prices would not budge, you'd probably wish for a strong dollar, a weak global economy, and a slow recovery in the U.S.

So what should we wish for?

Wish for a recovery, of course. Up to a third of the $147 price tag for 2008 oil came from investor speculation, according to one congressional report, and few people expect a sequel in 2011. With inflation weak, there's little reason for investors to pile onto oil commodities as a hedge. A strong global recovery will lift global wealth. It will enrich Americans, who will buy from Asia, which will enrich Asia, which will buy from America, and on it goes.

Oil probably won't kill the 2011 economy. But eventually, the world will have to find a way to satiate its relentless and growing appetite for energy that doesn't rely on a single scarce resource.