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Back in April 2009 I wrote a post which drew on the work of James Hamilton with regard to oil prices as the possible proximate cause of the Great Recession. Hamilton had pretty much nailed the decline in economic output that would result from an oil shock equivalent to the one we experienced in 2008 way back in 2003. He postulated that the explosion of crude prices turned what would have been a modest slowdown into the crisis we have just weathered.

This seems relevant as we are once more staring $100 crude in the face. Hamilton has some new work that would point to the possibility of another shock in short order. He published the three graphs below (click to enlarge) which show the speed at which crude prices can rise given the right circumstances (all figures are 2009 Dollars).

Hamilton goes on to note the striking similarities of the three graphs and concludes that among other things when demand for oil booms and supply is stagnant it’s not uncommon for the price of crude to quadruple. A phenomenon which, if it holds true, might spell another rough patch in our immediate future.

Notice that Hamilton’s graphs only continue for a year or two after the peak in prices. Using his source I was curious as to what happened to oil prices after the peak in 1980. Oil prices declined from a high of $95 in 1980 gradually to around $55 in 1985, then in 1986 they plummet to around $28 and pretty much stay under $30 until 2003. Contrast that with our recent history. We peaked around $97 fell back to $61 in 2009 and are now around $92. Crude provided a tailwind in the ’80s not now. How much the outstanding performance of the economy through the 1980s and for a good part of the 1990s is attributable to oil is a matter for some debate, but it probably wasn’t negligible.

So where does that leave us? Economists say that the price of crude is increasingly less important to the overall performance of the economy, based on the logic that GDP requires less energy input than in the past. Probably true as the economy has become more service oriented and less dependent on manufacturing. But, that doesn’t necessarily mean that consumer behavior isn’t meaningfully impacted by rising energy prices, perhaps in an outsized manner. Once the price of gasoline hits $3 a gallon we may well indeed see a retrenchment among consumers.

Where crude prices head is anyone’s guess. The conventional logic is that they are going up and I wouldn’t be inclined to quibble with that scenario. Based on past experience, I suspect that might spell more than a bit of trouble for the economy. Perhaps more to the point is that we don’t seem to have the prospect for an extended period of low oil prices such as we experienced after the 1981 recession. That might well be part of the reason we don’t have a robust recovery and a cautionary note as to the immediate future.

Source: Another Oil Shock Coming?