Oil prices signal another recession

Posted on 14 August 2011 with 4 comments from readers

Whenever before the cost of oil as a proportion of global GDP has hit current levels that has been a red alert for an imminent recession or meant that we are already in one. Will it be any different this time?

You can see the ‘oil expense indicator’ as a tax on business and consumers. You can see it as a natural break on consumption because oil supply is not infinite. Whatever, it means a recession.

Oil/GDP ratio

Oil consumption has averaged about three per cent of GDP since 1965 and has only three times been higher, each time saw a severe global recession: in 1974, 1979-85 and 2008.

Just a brief history reminder: 1973/4 was the first Arab Oil Shock with an oil embargo is response to war with Israel; 1979 was the Oil Shock that followed the Iranian Revolution; and in July 2008 oil shot to $147 in a debt-fuelled commodities boom and then sank to $34 by December in the global financial crisis.

Today oil prices are higher than where they should be at this stage in the economic cycle because of the loss of production due to the Arab Spring chaos this year and demand from emerging economies like China.

Oil prices are more than 10 per cent higher than where they should be to keep under the 4.5 per cent of global GDP mark. Moreover, it has been like this for over six months.

High prices are already cooling US demand, and may indicate that another US recession has actually already started. Year-on-year demand for gasoline was down 4.7 per cent in May. The last time this happened was in late 2007 and early 2008 in the run-up to the recession.

Household incomes are under pressure from rising food costs as well as energy prices this year, and this is particularly significant in emerging markets and lower income groups where these expenses comprise a bigger share of the family budget.

Consumer diffidence

Is it any wonder that US consumer confidence is at a 31-year low? Disposable income is being squeezed and people have less to spend.

Nobody even seems to be considering what would happen if the uprisings, revolutions and civil wars in the Middle East got worse rather than better this autumn, and yet if you project the current trend that is what you get.

The Oil States are enjoying the cash flow now, and starting to spend again but are also mindful of what another global recession would mean for oil prices.