History Lesson: Oil Price Spikes and Their Aftermath

by: James Shell

We were greeted with the following friendly banner on the EIA webpage this morning:

(Click to enlarge)

And we all know that the fuel price was caused by the 15% price spike that occured in the crude oil markets last week:

So I thought it might be fun if we could go back and look at similar occurrences, that is, price spikes of 15% within a 5-trading day period, and see if anything at all can be learned from history ... keeping in mind that we are probably in uncharted waters, with the crude oil price being in record territory for early Spring.

As it turns out, occurrences of a 15% price increase within five trading days (since the initiation of crude oil futures trading in the early 80's) is really rare, most of the occurrences were in the days of much less expensive oil:

On April 5, 1986, a nightclub in Berlin frequented by U.S. soldiers was bombed, investigation attributed the operation to Libya and within 10 days there was a retaliatory bombing strike after which the oil price returned to its pre-crisis level.

Later that year, an unnamed early season tropical depression formed in the Gulf of Mexico, threatening Houston. Actually this was probably more of a technical correction, the oil price had been beaten down into the low teens since the previous June, and after this event, the price gradually increased for the following couple of years until stabilizing in the low 20's in the 1988 time frame.

On April 19, 1989, there was an explosion on the USS Iowa ... which was actually in the Carribbean at the time. No terrorism, the market returned to its prior state a day or two afterward.

This is probably the only one that really matters, in August of 1990, Iraq invaded Kuwait, and for the following 100 days or so, sent the market into chaos. The price peaked out at 40 by early October, nearly doubling from its previous level, and the price remained elevated until January 16, 1991, when Operation Desert Storm started, causing the price to go from 32 to 19 in the course of 2 trading days ... In that era, we were importing about 5.5 mbpd crude oil, on average, and the resultant drain on the economy for that length of time caused economic contraction in the US for the fourth quarter of 1990.

At the end of the abominably bad weather winter of 1996, the stocks heating oil in PADD 1A, New England, had reached only three million barrels, and a late season blizzard caused some spot shortages. Within a day or two, it became spring, like it does, and the conditions returned to normal.

This technical market correction occurred after a nearly four-month beatdown of oil prices, the market retreated into the low teens for the remainder of the year.

This two day crisis occurred at the bottom of the market, the oil price returned to under 11 within a day or two.

The oil price nearly tripled anyway between January of 1999 and the fall of 2000, the bombing of the Cole agitated the market for a few days in October ...

This event occurred during the greatest unwinding of the oil market in history, during which the price of crude oil went from its all time high of 147 in the summer of that year to the mid-30's ... Category 4 Hurricane Ike struck the heart of the Gulf of Mexico oil infrastructure, and the temporary detour in the oil price was probably aggravated by a short squeeze because so many people were short the market as the economy was collapsing ...

There were actually a series of greater than 15% price gyrations during this period when the market was finding a bottom at its low point in 2009 ...

A couple of additional comments about the current situation:

At the current $15 price impact, and at our current import levels of somewhere between 8.5 and 9 mbpd, the incremental amount being extracted from the U.S. economy is nearly DOUBLE of our ENTIRE CRUDE OIL IMPORT EXPENSE during the 1990 Gulf War. Yes, you may quibble that the economy was much smaller at that point, but the longer this goes on, the more serious the potential impact;

So what did we learn on this:

  1. Most of the time, even the terror/fear events that cause a price spike like this are really temporary and resolve themselves in a few days. There is a lesson in this for everybody...
  2. In a few of the "political crisis" cases, the end came swiftly, and by actions on the part of the U.S. military that almost immediately calmed the market down. Even Desert Storm, in January of 1991, as violent as it was, caused a 1/3 correction in the price within a few days of its inception. Note that the Gulf War 2, which started in March of 2003, did not cause a price spike like this, and in fact, within a few days of the U.S. attack the oil price actually went down by 15%.
  3. The longer the problem goes on, the more of an impact it has on the U.S. economy. The 100-day or so price spike caused by the Iraq Invasion in 1990 did contribute to economic contraction in the US in the fall of that year.
  4. In light of "B" in combination with "C" above, is it not only a matter of time before the U.S. military gets involved in this situation with Libya, for no other reason than to calm down the oil market? We will have to let history unfold before us.
  5. Everyone complains about it correctly: We appear not to be able to learn to wean ourselves off of this vulnerability to imported crude oil. The problems are likely to become much more severe, the more expensive oil gets ... and the overall frequency of these price spikes may be less important than the upward steady pressure on the oil price which has gotten us at unprecedented seasonal crude oil pricing levels and threatens to be even worse by next year.

The world is chaotic. There are no guarantees on anything.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.