Oil Peaks: The Price of a Barrel of Oil in Hours Worked. By Ted Hinds

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Oil Peaks: The Price of a Barrel of Oil in Hours Worked By Ted Hinds The Price of a Barrel of Oil in Hours Worked is an economic statistic maintained by the Federal Reserve Bank of Dallas.

1 Oil Peaks: The Price of a Barrel of Oil in Hours Worked By Ted Hinds The Price of a Barrel of Oil in Hours Worked is an economic statistic maintained by the Federal Reserve Bank of Dallas. It is calculated by taking the average price per barrel of oil within a given calendar year and dividing by the average wage of production, nonsupervisory labor. Maintained for economic data back to 1890, the Price of a Barrel of Oil in Hours Worked (PBOHW) is a statistic that presents the relative cost of energy for an average wage earner in the United States. Though rarely cited, the PBOHW statistic is deserving of particular attention given the soaring costs of oil over the last two years as a result of U.S. War in Iraq, recent political turmoil throughout the Middle East, greater U.S. reliance on Middle Eastern oil, and the Bush Administration s supply-side energy policy. Chart 1: Price of Oil and Hours of Work (Source: FRB Dallas) A quick review of the PBOHW trend chart on the Dallas Fed website yeilds one immediate impression the price of a barrel of oil in real terms fell steadily for a century until approximately Spikes in that trend during the 20 th century have corresponded directly with periods of world war and strong economic recession. By the 1960 s, however, the PBOHW began to track nearly one-to-one, where the PBOHW has remained since with several important exceptions. The oil shock and sharp economic Page 1 of 1

2 recession of 1974, then the more prolonged recession of occurred at the same time as double digit increases in the PBOHW, year over year. The timing of the recession that occurred in the early 1990s, is also denoted by a spike in the PBOHW following the first Gulf War. Background Some discussion of the PBOHW statistic is warranted. Economic optimists have sought to downplay the effect of the current record costs of oil by stating that, in real terms, the cost of oil now is about where it was in Unfortunately this claim, which is often voiced by network news analysts, is somewhat disingenuous and probably more motivated by political concerns than thorough analysis. While technically true, the statement suggests that oil prices have only rearrived at a previous equilibrium level. Yet the price of a barrel of oil in 1981 was a short term spike in oil costs that happened to coincide with the worst economic recession of the last quarter century. Optimists also suggest that the United States may be less sensitive to energy shocks due to increased efficiency in the manufacturing and energy sectors, greater supply-chain utilization of capacity, advanced telecommunications, etc. Indeed, the energy to GDP ratio has declined by 50% since the 1980 s, according the Dallas Fed. Though the technological advances and greater productivity of the current U.S. economy versus that of the 1970s and 1980s is an objective reality, the argument that the US is less vulnerable to oil shocks in 2005 can be just as easily countered. Nearly one-fourth of all U.S. oil consumption is destined for gas and diesel production. The low PBOHW statistics that have prevailed over most of the last 30 years have certainly been a driving factor in the phenomenon of urban sprawl in America. More people are commuting farther distances to work now than they were in the 1970s. Furthermore, legislation exempting popular sport utility vehicles (SUVs) from CAFÉ standards have lessened the conservationist measures implemented in the late 70s. Though higher efficiency car engines like the new hybrid gas-electric models or more powerful alternatives like the Dodge hemi engine, which switches between eight cylinder and four cylinder modes and yeilds a 20% increase over traditional eight cylinder engines, are gaining in sales, they still represent a small number of the overall cars on the road. Therefore, the overall decrease in the energy-to-gdp ratio does not necessarily reflect decreased dependence on oil by consumers at the gas pump. Structural changes in the labor market over time are not represented in the PBOHW. The shift in the workforce from the more unionized manufacturing sector toward servicerelated occupations would suggest the PBOHW trend to be higher than the Dallas Fed statistic suggests, because wages in many service occupations tend to be lower and with less benefits like health insurance and retirement plans. With oil prices hovering around $50 per barrel since August 2004, the PBOHW is now at the critical multiple of +3.0 hours of labor for each barrel of oil (based on 2003 labor statistics, adjusted at +2.0% annually). As the corresponding graph indicates, such Page 2 of 2

3 energy costs for the average consumer have not been experienced since the economic recession of the early 1980s, when the nation was experiencing a deep recession. Chart 2: Price of a Barrel of Oil in Hours Worked Price of a Barrel of Oil in Hours Worked Chart 3: Percent Change in Price of a Barrel of Oil in Hours Worked (Year Over Year) Change In Price of a Barrel of Oil in Hours Worked (Year Over Year) 80% 60% 40% 20% 0% -20% -40% -60% Page 3 of 3

4 Perhaps even more ominous is the strong upward trend in the PBOHW, which has increased 100% since George W. Bush became President in Unlike the brief recession of , which coincided with a short term spike in the PBOHW, or the spike that occurred with the energy crisis in 1974, the current trend in oil costs has been long and increasing. Indeed, the only precedent for such a protracted period of rising energy costs since the price-controls of World War II were lifted is the economic malady of the early 1980s. In the five years between 1979 and 1983 when the PBOHW was highest, the Consumer Price Index in the U.S. increased 42.3%. Though such rampant inflation has yet to appear due to a near-zero federal funds rate, the doubling of the PBOHW since 2002 along with a soaring current account deficit may signal the end of any resistance the U.S. economy has left against inflation. Though the relationship between inflation alone and the most gruesome effect of economic recession, unemployment, is weak, this is not the case for the PBOHW. The correlation coefficient between the PBOHW and the unemployment rate since 1970 is strongly positive, measuring Chart 4: Unemployment at PBOHW Unemployment Rate PBOHW Prognosis Wall Street analysts and business reporters continue to remain optimistic about the current U.S. economy. The Federal Reserve Board has continued a measured increase in the federal funds rate of quarter point adjustments, while Chairman Alan Greenspan has remained his eternal policy of cautious optimism for the economy. Boosted in part by a generous, supply-side fiscal policy from the Bush Administration, corporate earnings have so far managed to shrug off the higher energy costs. Additionally, the Bush Page 4 of 4

5 Administration has sought reassurances from Saudi Arabia, the world s largest oil producer, to meet the demand for oil, as well as pursue a policy aimed at increasing the supply of oil through such controversial measures as opening up the Arctic National Wildlife Reserve in northern Alaska for exploration. However, the specters of trouble for the economy continue to cast their shadows on consumer confidence and the PBOHW is one of them. Real wages in the United States have fallen 0.9% so far in 2005, the sharpest decrease since Job creation remains tepid. In 2002, prior to the Iraq War, the price of a barrel of oil averaged $22.51 and within the Bureau of Labor and Statistics occupation categories, only 7.6 million Americans had incomes low enough that the price of a barrel of oil in hours of labor worked in at the average wage for their occupations put them over the 3.0 PBOHW threshold which has historically had such an adverse impact on the economy. Based on the same 2003 BLS employment statistics, by adjusting the price of a barrel of oil to the approximate current level of $50, the number of people employed in occupations where the average wage puts them above the 3.0 PBOHW has shot up dramatically to 80.4 million people, or 67% of the American workforce. The ability of the American worker to absorb that kind of increase in their autonomous consumption, or that amount of a household income dedicated to costs associated with maintaining its livelihood, is the key to how damaging the current PBOHW will be to the economy. By definition, a decrease in disposable income must occur and it s unlikely that the Bush tax cuts for capital gains or dividend income will buffer the impact of high energy costs for the bottom 67% of American wage earners. The ballast to the economy that historically low interest rates have had on property values and the boom in the mortgage refinancing industry is likely to fade as interest rates rise. Credit card debt is already at its highest point in history and the U.S. savings rate remains very low. One effect of a prolonged, high PBOHW will be a gradual shift in the demand curve from superior goods and services toward inferior goods and services as consumers change buying habits to stretch their budgets. Though sellers of luxury goods that cater to the upper 10% of the income distribution will probably not feel the effects, sellers and products that are targeted at the middle income families should see an erosion of market share as consumers are forced to make more frugal purchasing decisions. The large, discount retailers like Wal-Mart and Target stores should gain. This will make the importance of the cheaper import products they sell even greater, thus adding more fuel to the furnace of economic growth in China and other nations which are demanding a larger share of the world s oil supply. If such a trend results in greater polarization of demand between inferior goods and superior goods, layoffs and store closures for companies that have traditionally targeted the strong American middle class (e.g. JCPenney, Gap, etc.) could send the unemployment rate up to early 80s highs along with the PBOHW. Page 5 of 5

6 Prescription Some measures could be implemented through changes in fiscal policy and legislative action to bring the PBOHW down from its fearsome height for many Americans. A two pronged approach to the current energy crisis that would focus at least an equal amount of attention on demand for oil could have an immediate effect on prices. After its introduction, the Corporate Average Fuel Economy (CAFÉ) standards made a 40% increase in automobile fuel efficiency between 1978 and Inclusion of sport utility vehicles would provide more incentive for automakers to speed development of more fuel efficient engines for these popular autos. Tax credits or deductions for consumers who purchase one of these vehicles or replace the engine with a hybrid design would also help and, if timed properly, might help stimulate sales from struggling Ford and GM. A more cautious approach to global free trade would also help to lessen the downward pressure on wages in the U.S. Finally, a foreign policy that does less to incite conflict and create the appearance of an American energy grab in the important Middle East would make nations outside of that region, like Russia and Venezuela, more willing to allow U.S. investment to make their oilfields more productive. In other words, give peace a chance. Page 6 of 6

ECONOMIC CURRENTS. Look for little growth in the first half of High energy costs and cooling housing market a drag on near term growth

ECONOMIC CURRENTS. Look for little growth in the first half of High energy costs and cooling housing market a drag on near term growth T H E S T A T E O F T H E S T A T E E C O N O M Y ECONOMIC CURRENTS Look for little growth in the first half of 2006 High energy costs and cooling housing market a drag on near term growth MODERATE GROWTH