Greasing the wheel: Oil’s role in the global crisis
|Lucas Chancel Thomas Spencer
16 May 2012
Between January 2002 and August 2008, the nominal oil price rose from $19.7 to $133.4 a barrel. This column gathers evidence on the role of this rise in prices in the global crisis. It suggests that oil prices had a direct impact on household expenditure on gasoline and increased mortgage delinquency rates. It adds that it also had many indirect impacts, notably though interest rate increases due to monetary policy.
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)
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:
A number of contextual factors also interacted with the oil price increase to potentially worsen vulnerabilities:
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.
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.
From this analysis we draw a number of suggestions for further consideration.
Consumer Expenditure Survey, US Bureau of Labour Statistics
Edelstein, P and L Kilian (2009), “How sensitive are consumer expenditures to retail energy prices?”, Journal of Monetary Economics 56(6).
Federal Reserve Bank of New York (2006), Current Issues in Economics and Finance 12(9).
Freilich, R, R Sitkowsky and S Mennillo (2010), From Sprawl to Sustainability: Smart Growth, New Urbanism, Green Development, and Renewable Energy, 2nd ed, Chicago: ABA Books.
International Monetary Fund (2006), “Oil Prices and Global Imbalances”, World Economic Outlook, Chapter 2 .
Spencer, Thomas, Lucas Chancel, and Emmanuel Guérin (2012) “Exiting the EU crises in the right direction: towards a sustainable economy for all”, IDDRI Working Paper
International Energy Agency (2011), World Energy Outlook, Paris: IEA.
Kaufman, R, N Gonzalez, T Nickerson and Y Nesbit (2010), “Do household energy expenditures affect mortgage delinquency rates?”, Energy Economics 33(2).
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