Oil Prices and Sumner’s Standing Order

Looks like oil prices are climbing again. If the economy keeps recovering, this increase is going to last a big longer than the last few. Calculated risk looks to James Hamilton in these situations. I’ll swipe a quote from an old Hamilton post via CR:

In my 2003 study, I found the evidence favored a specification with a longer memory, looking at where oil prices had been not just over the last year but instead over the last 3 years. My reading of developments during 2011 has been that, because of the very high gasoline prices we saw in 2008, U.S. car-buying habits never went back to the earlier patterns, and we did not see the same shock to U.S. automakers as accompanied some of the other, more disruptive oil shocks. My view has been that, in the absence of those early manifestations, we might not expect to see the later multiplier effects that account for the average historical response summarized in the figure above. If one uses the 3-year price threshold that the data seem to favor (e.g., equation (3.8) in my 2003 study), the inference would be that we’ll do just fine in 2011:H2, because oil prices in 2011 never exceeded what we saw in 2008.

Great stuff. We’re in a world where oil prices have stayed up long enough that the economy is adjusting to a new level of scarcity.

The other day we are treated to some more analysis:

The first question to be clear on is which crude oil price we’re talking about. Two of the popular benchmarks are West Texas Intermediate, traded in Oklahoma, and North Sea Brent. Historically these two prices were quite close, and it didn’t matter which one you referenced. But due to a lack of adequate transportation infrastructure in the United States, the two prices have diverged significantly over the last year.

Interesting stuff. Here’s a lot more from Hamilton on the Keystone XL pipeline. He’s definitely the best authority I know of on this stuff.

Anyway, now that it’s high oil price season again, I’m reminded of something Scott Sumner has taught me to watch out for, which he always talks about. I’m calling it his standing order: Never reason from a price change.

So what does this mean? Start with this quote:

One factor that’s been driving Brent and WTI up over the last few weeks has been rising tensions with Iran. But why should threats or fears alone affect the price we pay here and now? Phil Flynn, a senior market analyst at PFGBest Research in Chicago, offered this interpretation…

Ok, pop quiz: what happens to oil consumption in the US?

Think about what happens to consumption as the oil price rises and you’d say that consumption goes down. But you’d probably be wrong.

Sumner teaches us to ignore the price change when talking about its effects. Focus on the cause of the price change. What does a big problem in Iran mean for the US economy, other than oil? Not much.

The right answer, then? Oil consumption doesn’t change.

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