Petroleum Prices and the International Dimension

Paul Krugman observes that there are many real side factors that should drive oil prices higher (in an article that cites Jim’s 2009 paper). I certainly don’t have much to add in terms of thinking about oil prices and domestic macro implications, but Krugman’s note did impel me to examine more closely the international aspects of the underlying demand factors.

Figure 1 depicts the changes (not percent changes) in oil consumption in millions of barrels per day, by economy.  

op1.gif

Figure 1: Changes in petroleum consumption, in millions of barrels per day. Actual data for 2000-2009 from EIA. Forecasts from 2010 onward, from EIA, Annual Energy Outlook, 2011 (preliminary version, December 15, 2010), and author’s calculations. Note: The definition of “rest-of-world” for forecast data is sum of OECD+non-OECD.

Clearly, in 2008 and 2009, due to the slowdown and then deep recession (which even in September 2008, Don Luskin was still disputing), oil consumption declined. As Figure 1 illustrates, 2010 is a year of rebound in petroleum consumption growth, with Chinese consumption resuming its growth. One interesting highlight is that the pattern that held before the Great Recession, of Chinese consumption growth exceeding US growth, has re-asserted itself. Given the resumption in world consumption, it’s no surprise that prices have re-established themselves since mid-2009, as shown in Figure 2. (For an earlier discussion of China’s role, see this CBO report from 2006).

op2.gif

Figure 2: CPI less food and energy, seasonally adjusted (blue, left scale), and price of petroleum, WTI, (red, right scale). December 2010 observation (red square, right scale) is nearest month futures price as of 12/27. NBER defined recession dates shaded gray. Source: FRED II for core CPI and price of petroleum, and Bloomberg.com for petroleum futures price, and NBER.

Figure 2 also plots core CPI. Clearly, since core CPI has been fairly level since late 2009, the relative price of oil has risen since the depths of the recession. No surprise there (except to note that rising oil prices have not been matched by rising actual cost of living indices, or expectations of accelerating inflation). This last observation is consistent with real side factors, rather than inflationary forces, driving oil prices. (Here’s Jim’s take from mid-2009, a time when people were also worrying about inflationary pressures, as well as his take on QE2’s effect on oil prices.)

Oil futures do not point to ever higher oil prices. As of today, in fact, while the forward curve is in contango, the futures price three years ahead is only slightly above the nearest month futures price.

op3.gif

Figure 3: NYMEX petroleum futures, as of 12/27/2010, 1:34 PM. Source: NYMEX:CL, www.ino.com. Nearest month futures from Bloomberg.

There are many skeptics of futures as predictors of future commodity prices (or any given asset price). I won’t claim that futures are great predictors (they explain about 6% of the variation in changes in oil prices at the one year horizon); merely that they are, for petroleum, close to unbiased, and are rarely beaten by a typical estimated time series model. [1] [Chinn/Coibion, 2010].

The fact that China figures so prominently in the growth of world consumption is significant, because it highlights the fact that oil prices will depend on trends in Chinese GDP (as well as measures to decrease oil intensity) [1]. The PBoC’s Christmas Day increase in interest rates serves as a reminder of the fact that the Chinese authorities face a challenging task in deflating the asset bubbles and re-balancing the economy without overshooting.[2] (Interesting tangent, on how the yuan fits into the inferred policy mix, here).

It also highlights why one should expect lots of volatility in oil prices. In addition to the uncertainty surrounding the path of the Chinese economy, it’s useful to remember that the short run price elasticity of oil demand (as well as supply) is usually considered quite low. Then small shifts in the demand curve should induce relatively large movements.

One last observation regarding the monetary/real debate over the oil price resurgence. If indeed oil prices were rising over the past month primarily because of monetary policies in the US, one would expect the oil price change in the US to diverge from that in other economies not undertaking another round of quantitative expansion. Figure 4 shows the price of oil expressed in dollars, and in euros.

op4.gif

Figure 4: Dollar price of petroleum (red), and euro price (blue). Euro price is WTI price adjusted by dollar/euro exchange rate. December 2010 observation pertains to 12/27/2010. Source” FRED II, and author’s calculations.

For the jump in prices during December, I don’t see a pronounced divergence.


Originally published at Econbrowser and reproduced here with permission.