Publications: Notes at the Margin

Disruptions: Lessons from the Past (Notes Supplement, September 16, 2019)

 

After tracking every oil market disruption since 1973, I have observed a consistent pattern. The first response to a disruption in every case involves energy officials dismissing its market impact. On all occasions, they have told consumers that oil is plentiful and asked buyers to believe markets were still balanced. Consumers, whether individual drivers or refiners, have never swallowed such claims. Tanks were filled.

 

The second response comes from oil producers. After every disruption, no other oil producers rushed to increase output. To the contrary, they found reasons to cut it.

 

The third response comes from the elites, who dismiss the possibility of economic impacts. I am in France, so I cannot pull items from my file on prior disruptions. However, I believe I have articles—often from President Trump’s favorite source, The New York Times—asserting that such events would have no economic fallout.

 

The fourth response comes from governments, which have consistently told consumers that strategic stocks were not meant to be used to moderate price increases.

 

Inevitably, the consequence of these responses has been significant price rises and, in many cases, measurable economic effects.

 

This Disruption: Not Much Different

So far, the reactions to the attack on the Saudi oil production facilities are following the script. Immediately after the news, the International Energy Agency assured the world that global supplies were more than adequate to meet demand. After this announcement, oil producers issued statements Monday that, rather than boost production, they would sit back and enjoy the benefits of higher prices.[1] At the same time, some New York Times reporters opined that the disruption’s impact would be minimal.[2]

 

Donald Trump has differentiated this event in one respect: strategic stocks. I am convinced the IEA’s secret manual for dealing with disruptions states explicitly that strategic reserves should never be used. Trump did not get the message. Sunday, he announced that oil from US strategic holdings would be released if needed. One can be sure the bureaucrats will work diligently to keep this from happening.

 

Impact on Consumers

At this juncture, the predicted price increase from the Saudi disruption is one hundred four percent. This implies that Brent is headed for $125 per barrel. Should Brent go to $125, US retail gasoline prices would rise sixty-five percent to around $3.75 per gallon, assuming full passthrough of the crude price increase. Of late, US consumers have been spending two to three percent of income on gasoline. This will rise to between four and five percent, percentages last observed in 2007 and 2008, if gasoline prices go up, which in turn will force them to spend two percent less on nonfuel items.

 

The two-percent loss in consumer expenditures roughly equals the amount of GNP growth expected by most forecasters. The implication, then, is that a loss in Saudi crude production of five million barrels per day will likely lead to a recession—just as in past episodes.

 

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