Wednesday, August 12, 2009

Another oil price shock - not likely

There has a a lot of talk about the speculators driving prices up in the oil market but less talk about the root causes for oil price moves. Prices have moved form a low of $45 per barrel to current levels in the high $60's. We are in the 2006 range for oil which is consistent with a global economy that is growing around the longer-term trend. hat may be premature but the numbers seem plausible.

We are not seeing a price shock. Lutz Kilian in the Journal of Economic Literature provided a good breakdown the type of shocks that could occur and there impact one the US economy. He defines three types of energy shocks:
1. Supply shocks from the interruption of oil. These are usually temporary and do not have a lasting effect on h economy.
2. Demand shocks from aggregate global demand for oil. These would be a response to economic activity as opposed to the behavior of the oil market.
3. Oil-specific demand shocks which are associated with political uncertainty. There is an increase in demand to increase inventory as a convenience. This is usually what has been perceived as price shocks by market observers historically, but most of what we have been dealing with has been global demand shocks. These are the shocks which have the most impact on the economy.

So do we have a shock? Most likely we are dealing with the normal increase in demand associated with a turn in the business cycle. No shock. Prices should sty in this range unless there is a significant increase in global growth.

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