Wednesday, June 24, 2009

With the price of oil creeping upwards, are we in danger of a new recession?

With the price of oil creeping back up, folks in the energy patch are beginning to breathe cautious sighs of relief. While higher costs per barrel generally have positive effects on the industry, how high is too high?

New research by Wall Street energy business analysts, Douglas-Westwood LLC, suggests that when oil consumption costs exceed 4% of US GDP, recession almost always occurs. And in general, a sustained rise in the oil price of 50% or more has always been followed by a recession.

"In every case when oil consumption breeched 4% of GDP, the US suffered a recession and indeed, the current US recession began within two months of oil hitting the 4% threshold, most recently, when oil reached $80 a barrel," said Steven Kopits, managing director at Douglas-Westwood.

Another factor is the maximum rate of adjustment for the economy, which appears to be about 0.8% of GDP per year. That is, the economy cannot shed oil consumption instantaneously; society needs time to adjust. When the economy is adjusting at full speed, it will tend to struggle. Adjustment will tend to be characterized by recession, inflation or generally low GDP growth.

"Our research suggests that a return to $80 oil could kill the present recovery and trigger a new recession – today's oil prices means we are again teetering on the edge," he added.

While last year's $140/barrel oil proved fruitful for the industry, the benefits were short-lived and companies were left struggling in the depths of the recession. An increase in the price of oil is needed to get companies and the economy back on track, but at what price do we risk a new recession?

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