What caused the Spring 2008 spike in oil prices?

Bad news, but not a surprise:   oil demand has become less responsive to prices.   This explains much or all of the Spring 2008 spike in oil prices.  World GDP had grown at 5%+ for 5 years, and oil production could not keep up.  Large increases in oil prices were the only way to balance oil suppy and demand.  This is a follow-up to Colonel Lang shows us why the 21st century might prove difficult – even painful – for America (26 August 2008), discussing the alternative theory that prices rose mostly because of speculation.  This means the early years of peaking oil production will see rapid price increases!

James Hamilton summarizes current energy research in “The challenges ahead for world oil“, at his Econobrowser, 14 March 2010 — Excerpt:

Research by Baumeister and Peersman and Hughes, Knittel, and Sperling, among others, has documented that oil demand appears to have been much less responsive to price over the last decade than it had been in the 1970s. My recent study in the Brookings Papers on Economic Activity (published version here, working paper version here) concluded that this decrease in the elasticity is one of the key factors behind the oil-price run-up of 2007-2008.  The surprise to markets in 2008 was that even $100 oil wouldn’t be enough to prevent world demand from growing above 85 million barrels a day, and much more than 85 million barrels a day simply wasn’t going to be produced at that time.

He references some research that has been posted on the FM website.  Such as “Causes and Consequences of the Oil Shock of 2007-08“, James D. Hamilton, National Bureau of Economic Research, May 2009 — Abstract:

This paper explores similarities and differences between the run-up of oil prices in 2007-08 and earlier oil price shocks, looking at what caused the price increase and what effects it had on the economy. Whereas historical oil price shocks were primarily caused by physical disruptions of supply, the price run-up of 2007-08 was caused by strong demand confronting stagnating world production. Although the causes were different, the consequences for the economy appear to have been very similar to those observed in earlier episodes, with significant effects on overall consumption spending and purchases of domestic automobiles in particular. In the absence of those declines, it is unlikely that we would have characterized the period 2007:Q4 to 2008:Q3 as one of economic recession for the U.S. The experience of 2007-08 should thus be added to the list of recessions to which oil prices appear to have made a material contribution.

Other articles about oil prices

  1. Evidence of a Shift in the Short-Run Price Elasticity of Gasoline Demand“, Jonathan E. Hughes, Christopher R. Knittel and Daniel Sperling (UC Davis), The Energy Journal, January 2008
  2. Ending Dependence: Hard Choices for Oil-Exporting States, John V Mitchell and Paul Stevens, Chatham House, July 2008
  3. The Dilemma of Oil Depletion“, Glada Lahn, Chatham House, June 2009 — An update to the above report.
  4. Time-Varying E¤ects of Oil Supply Shocks on the US Economy“, Christiane Baumeister and Gert Peersman (Ghent U), October 2009
  5. How Changes in Oil Prices Affect the Macroeconomy, Bank of Canada, Brian DePratto, Carlos de Resende, and Philipp Maier, December 2009
  6. World oil demand’s shift toward faster growing and less price-responsive products and regions“, by Joyce M. Dargay and Dermot Gately (NYU), February 2010

For more information

Other articles about oil prices and market speculation:

  1. Colonel Lang shows us why the 21st century might prove difficult – even painful – for America, 26 August 2008
  2. What’s up with the price of oil?, 24 November 2008
  3. What caused the Spring 2008 spike in oil prices?, 22 April 2010
  4. Science: “Oil Peak or Panic?”, 20 May 2010

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