Mcteer On Energy Intensity

Robert McTeer of the Dallas Fed had a commentary on energy in Tuesday’s WSJ (sub. req.). His argument is basically that our economy has become less responsive to energy price volatility, and therefore we should not be as concerned about the negative consequences for the economy from high oil and natural gas prices as we would have been in the past. This extensive excerpt makes his point:

There’s little mystery in the link of energy prices to recession. Consumer spending takes a hit as budgets stretch to pay more for filling up at the gasoline pumps and heating homes. Just as important, oil products and natural gas are key inputs for electricity, airlines, trucking, petrochemicals, fertilizer and a host of other industries. Those vulnerabilities haven’t gone away, and that’s why the recovery slows.

How much depends on what happens to energy prices. Take the outlook suggested by futures markets — oil prices 35% higher than previously forecast and natural gas prices about 30% above their historical relationship with oil. That puts oil at $30 to $32 a barrel and natural gas at $5 to $6 per million BTU.

Under this scenario, Dallas Fed research suggests GDP would suffer a one-time reduction of 0.9% — not all at once but spread out over several years. An economy racing forward at 3.5% to 4% annually can weather the loss of several-tenths of a percentage point. A decade or two ago, a similar run-up in oil and natural gas prices would have done more damage to the economy. Three factors explain why we’ve become less sensitive to energy-price shocks:

First, shifts in the composition of output and investments in more efficient plants, equipment, homes and vehicles have cut the energy-to-GDP ratio by more than 50% since the early 1980s. In the airline industry, for example, the average fuel per passenger mile has fallen by about 25%.

Second, today’s price hikes aren’t as severe as many of the past episodes. Adjusted for inflation, for example, today’s crude prices would have to rise to $75 to $80 a barrel to get where they were in 1981, which would mean gasoline prices of $3.50 per gallon or higher.

Third, the economy benefits from experience gained over the years in dealing with higher energy prices. Companies that survived past episodes are less likely to misjudge the impact of expensive oil and natural gas on their own businesses and on others with whom they trade.

An economy less susceptible to energy price volatility comes as a blessing because prospects aren’t good for the kind of price busts that in the past brought relief from expensive oil and natural gas.

For more on McTeer’s comments, see this Reuters article from Tuesday.