This is a guest post by Lucas
Chanel, Research Fellow in economics, and Thomas Spencer, Research
Fellow in climate and energy policies, both at the Institute for
Sustainable Development and International Relations.
Between January 2002 and August
2008, the nominal oil price rose from $19.7 to $133.4 a barrel. This
led to a large increase in oil revenues for oil exporters and a
deterioration of the current account for oil importers (Figure 1).
Between 2002 and 2006, net capital outflows from oil exporters grew
by 348%, becoming the largest global source of net capital outflows
in 2006 (McKinsey 2007).
Capital outflows from oil exporters
therefore played an important role in the global liquidity glut
during the build-up to the US subprime crisis. Analysis of direct
capital flows is hampered by the lack of reporting transparency and
the use of foreign financial intermediaries. Indirect recycling also
took place, i.e. direct oil-revenue investment in a given financial
market led to corresponding knock-on flows towards the ultimate net
borrower. Nonetheless, analysis from the US Federal Reserve suggests
that “…most petrodollar investments [found] their way to the United
States, indirectly if not directly” (Federal Reserve Bank of New
York 2006). In short, the US was the ultimate net borrower, in order
to finance its growing current account deficit.
Figure 1. Merchandise and fuel
current account: US and major oil and gas exporters (MOGE) Source:
UNCTAD.
Such capital flows were invested in
US treasuries, corporate bonds, equities, and asset markets. In
turn, this placed downward pressure on US interest rates and helped
fuel further borrowing. Quantifying the specific contribution of
oil-revenue inflows is difficult. Nonetheless, oil revenues do seem
to have reduced US interest rates (see IMF 2006 for a discussion).
In sum, the direct and indirect recycling of oil revenues was a
factor in the global liquidity glut that helped to fuel the US
subprime mortgage crisis.
Bursting the bubble
Oil prices also played a role in
eventually bursting the US subprime bubble. As we document in a
recent working paper (Spencer et al. 2012), this occurred via a
number of channels which are difficult to disentangle. It is also
next to impossible to identify the threshold of mortgage
delinquencies, which led to the meltdown in the subprime market and
then global financial markets. Nonetheless, one can examine the
individual channels through which oil prices contributed:
• Direct impacts
on discretionary spending. Between 2002 and 2008, average household
expenditure on gasoline rose 120%, from $1,235 to $2,715, or by 2
percentage points of overall household expenditure (CES 2011). For
(poorer) suburban households this effect was even more pronounced.
In 2003, the average suburban household spent $1,422 a year on
gasoline, which rose to $3,196 in 2008 (Freilich et al. 2010).
Kaufman et al. (2010) show, using VAR analysis, that rising
household energy prices constrained household budgets and increased
mortgage delinquency rates, once other factors are controlled for.
• Indirect
impacts of interest rate increases. The federal fund rate rose from
1% in May 2005 to 5.26% in March 2007. A quick read of the Fed’s
Monetary Policy Reports shows the recurring importance of energy
price concerns in the Fed’s decisions to raise the fund rate. Annual
mortgage repayments for an average household increased by 33%
between 2004 and 2007 (CES 2011).
A number of contextual factors also
interacted with the oil price increase to potentially worsen
vulnerabilities:
• Labour market
interactions. Peersman and Van Robays (2009) show that the
inflationary impact of the oil price shock from 2004-8 was reduced
in the US due to the structure of the labour market. Producers used
a strong bargaining position to pass the cost burden onto consumers
through a reduction in real wages. Thus, while second-round
inflationary impacts were mitigated, this was at the expense of a
decline in real wages. This had negative impacts on aggregate demand
(see below), and constrained household budgets.
• Distributional
impact of energy prices. Energy price shocks have strong
distributional effects, mostly impacting energy expenses of suburban
households and low-income households spending a greater income share
on energy. Subprime mortgage loans were also concentrated on poorer
households, leading to a confluence of risk factors.
• Maladapted
urban planning. Between 1969 and 2001, the annual average distance
driven per licensed driver increased 90%, from 5,411 to 10,244 miles
per year (NHTS 2009). The heavy reliance on personalised vehicle
transport increased oil price risk exposure among US households.
• Fuel
inefficiency of the vehicle fleet. Sivak and Tsimhoni (2009) show
that the fuel efficiency of the US vehicle fleet barely improved
from 1991 to 2006, increasing from 16.9 to 17.2 miles per gallon.
The figures for Europe are 31.2 in 1991 and 35 in 2006.
Finally, increasing oil prices had
an impact on aggregate demand. This operates via a number of
channels – reduced discretionary income, increased precautionary
savings, and operating cost effects, whereby consumers are deterred
from purchasing energy-intensive goods, and reallocation effects. In
particular, the auto sector played an important role in transmitting
the shock. Between the peak in 2003 and the last pre-crisis year,
2007, household expenditure on vehicle purchases fell 13%.
Expenditure on more energy-intensive, domestically produced autos
likely fell further, as indicated by Edelstein and Kilian (2009).
The decline of the US auto sector was an important contributing
factor in tipping the US into recession in 2007Q4, although there
was clearly a mutually reinforcing interaction between the
recessionary slide, which began in 2007Q3, and the subsequent
further decline of the auto sector in 2008.
Outlook
Taking IEA (2011) projections, we
calculate the size and distribution of oil revenues (petrodollars)
from net oil trade to 2035 (Figure 2). The US starts the period in
2010 as the largest source of petrodollars, at -$296 billion using
the average 2010 price of $79 a barrel. The EU27 is next with -$281
billion. The Middle East gains net oil revenues of $539 billion.
Figure 2. Average annual net
oil revenues 2010-2035 Source: IEA 2011
US oil-import dependence declines
towards 2035, due to improved energy efficiency particularly in the
transport sector and increased domestic production, in particular
from shale oil. The EU27 overtakes the US as the largest source of
petrodollars by 2020. China and India become the largest and third
largest source of petrodollars respectively by 2035; China assumes
premier position by 2025. The figures are based on the IEA New
Policies Scenario, which assumes further energy efficiency and oil
substitution. The Current Policies Scenario sees oil prices 8% and
16% higher in 2020 and 2035 respectively, increasing petrodollar
flows correspondingly. A more disaggregated picture, focusing on
major oil-exporting countries within the Middle East and African
region would show an even stronger concentration of oil revenues.
Conclusion
From this analysis we draw a number
of suggestions for further consideration.
• The oil price
appears to have played a role in the subprime crisis. Understanding
macro impacts of oil prices also requires considering in detail the
exposure and interactions of micro channels, such as the housing or
auto sector.
• Oil prices
played a key role in worsening the balance-of-payment imbalance
leading up to the crisis. This will continue to strengthen, and
China and India will play an increasing role as net exporters of
petrodollars. The efficient intermediation of petrodollars
represents a large challenge to the financial sector, and
potentially economic stability in general.
• Policies to
address oil dependency via substitution, efficiency, and
conservation can reduce micro- and macro-level exposure to oil price
risks, and contribute to addressing global imbalances.
This article first appeared in
The Oil Drum | Sun, 27 May
2012.
Creative
Commons License
To subscribe or visit go to:
http://www.platts.com