A number of studies have shown that high oil prices have been a major factor in causing recessions in the United States. The cause of previous high oil prices has often been tied to events such as strikes in oil producing nations (e.g. Venezuela), wars (Iraq invading Kuwait, the Iran/Iraq war, the Gulf war), oil embargoes (Saudi Arabia and other OPEC nations cutting off oil supplies to countries that supported Israel in the Yom Kippur war), and revolutions like the Iranian revolution. In one form or another all of these events could be grouped together as political events that caused high oil prices that initiated recessions in the United States (and elsewhere). Some of the past variations in oil prices were also due to the limited ability of Saudi Arabia to use its great oil reserves and refining capacity to control other OPEC members. Politically initiated high oil prices end when the politics change and oil can again flow from suppliers to consumers.
These recessions caused a decrease in demand for oil which, in turn, caused a significant drop in oil prices. Lower oil prices, particularly for a country like the United States which is so dependent on large amounts of imported oil, acted like a stimulus program. This stimulus helped end the recession and as demand once again increased, oil prices rose back to more typical levels. So, over the past few decades we have had a series of recessions and recoveries, all largely tied to oil prices.
All this has now changed. The high price for oil that occurred in 2008, sending the world into a deep recession, was not the result of a political initiator. Rather it was a new kind of recession initiator, which I call a physical initiator. In 2008 the margin between oil supply and oil demand effectively went to zero. Oil prices were already rising prior to the peak price of about $147/barrel, but at this price the economy could no longer sustain itself. This rapid collapse exposed many other financial weaknesses, especially in the housing market and the extreme risks that large banks, AEG, investment companies, Freddy Mac, and Fanny Mae were taking. Once the recession hit, oil consumption worldwide, and especially in the United States, dropped and in doing so, recreated a temporary margin between oil supply and demand. As nations begin to climb out of their recessions this temporary margin will erode, setting the stage for another spike in oil prices and additional recessions in nations already weakened by the first (2008) recession. A second spike may not be too far off.
Not only are physically-initiated recessions – those where there is zero margin between global supply and demand – different from past politically-initiated, oil-related recessions, recovering from them is also different. There is no national stimulus recovery force from low priced oil. Oil prices have remained high and will continue to do so because of two major factors:
(1) Much greater demand for oil from China, India, Brazil, and many other developing nations; and
(2) The limited ability to find enough new oil to offset the depletion of older oil fields.
Unlike politically-initiated times of high oil prices, there are no quick oil margin-building actions that can be taken to restore adequate inventory when there are physical limitations on oil supply. These two new major factors are putting great pressure on countries to find oil in ever more expensive and environmentally-sensitive areas. Often the marginal barrel of oil results in a greater release of greenhouse gases per barrel, such as getting oil from Canada’s tar sands, than conventional oil.
We already see other significant differences between this recession and all past ones. A comparison of the employment recovery rate this time around is far slower than any other recession… likely the result of a lack of economic stimulus from low oil prices. Previous estimates of when employment figures would be near normal, such as that from former Secretary of Treasury Lawrence Summers, have been far off because, it seems, these economists have not recognized that a major economic force that drives this nation has changed. It is not even clear that government-planned stimulus plans will be effective in the long run. Greater economic activity will result in higher oil prices which could then wipe out employment gains. This recession is different from other, earlier, recessions. And that difference is the global demand for oil.
Given the context of how oil dependence is shaping our economy, I pose two questions: How do we optimize national security in a world where our economic vitality depends on competing for every last drop of oil? Is it possible – physically and economically – to prevent excessive climate change and continue to use oil at current rates?