500 per cent increase in oil prices may be the key driver behind global recession: CIBC World Markets report

Nov 3, 2008

    Americans' cost of importing oil up US$200 billion a year

    TORONTO, Nov. 3 /CNW/ - CIBC (CM: TSX; NYSE) - The staggering rise in oil
prices since 2002 may be playing a far more significant role in pushing the
global economy into a recession than the sub-prime mortgage meltdown in the
U.S., finds a new report from CIBC World Markets.
    The report, titled "Just how big is Cleveland?", challenges how falling
property values in U.S. inner-cities like Cleveland could create a recession
in Japan and the Euroland economies, before even causing a recession in the
U.S. economy.
    "Four of the last five global recessions were caused by huge spikes in
oil prices. And the world economy is coming off the mother of all spikes,"
says Jeff Rubin, chief economist at CIBC World Markets. "Over this cycle, real
oil prices have risen over 500 per cent, twice the rise in real oil prices
that produced the two biggest recessions in the post-war era: the 1974
recession and the double-dip recession in 1980 and 1982.
    "If oil shocks half the size of the recent one caused the worst
recessions in the last fifty years, they're a pretty obvious explanation for
the recessions in oil-dependent Japan and Euroland earlier in the year. And
even back in Cleveland, few could doubt the link between $4/gallon gasoline
last Memorial Day weekend and what's happening in Detroit today. And from
where the U.S. economy currently stands, vehicle sales have a much bigger
downside than housing starts."
    The report notes that in the past, oil shocks have triggered global
recessions by transferring billions (or now trillions) of dollars of income
from OECD economies with typically very low savings rates to OPEC economies
with typically very high savings rates. For example, the transfer of income
from U.S. consumers to Saudi producers involves moving money from basically a
zero-savings-rate economy to one in which the saving rate is around 50 per
    "While many of those petro-dollars get recycled back into the financial
assets of OECD countries, many of them never get spent," adds Mr. Rubin.
"Hence, the redistribution of global income from oil-consuming countries to
oil-producing countries is far from demand-neutral insofar as the global
economy is concerned.
    "Those same transfers are occurring now, and at recent triple-digit oil
prices, they are occurring on an even more colossal scale than ever before.
The annual U.S. oil import bill has risen by a staggering $200 billion since
2005. That's bigger than Congress' entire fiscal stimulus package."
    This scenario has been true for the incomes of all OECD countries. Over
the last five years the fuel bill has grown a staggering $700 billion
annually, with $400 billion of this going to OPEC producers. In effect, these
massive cash transfers mean that more and more of the world's income gets
saved and less and less spent. That demand leakage shows up in a weaker world
    The report notes that both the Japanese and European economies are far
more vulnerable to oil price spikes than the American economy. While the U.S.
economy consumes 19 million barrels per day, 5 million of those are produced
domestically - and that part of the American economy gets a boost from soaring
oil prices. Japan, on the other hand, must import nearly all of its oil. With
the exception of Russia and a few North Sea states, Europe is essentially the
same. As a result, these economies are almost twice as sensitive to an oil
shock as the American economy.
    But the American economy is also vulnerable. "The one-two punch from
record fuel bills and end of the tax rebates saw consumer spending plunge at a
3.1 per cent rate in the third quarter, the largest decline in over a quarter
century," says Mr. Rubin. "Significantly, the last drop in household spending
occurred in a previous energy shock, caused by the 1990 Iraq war.
    "Plunging motor vehicle sales accounted for the largest single component
of the drop in Q3 spending. And the risk is that the damage there is far from
done. The past year's high pump prices have not only decimated sales but
sparked a discernable, potentially lasting reduction in miles driven. Nor is
the damage from high oil prices limited to automobiles. Four-fifths of GDP
shows a strong negative relationship to high energy costs. That includes the
negative effect on a wide range of industries, including travel and
agriculture, which increasingly just turns petroleum into food."
    The report also notes that research has found that that it takes about a
year for an oil price shock to have its maximum impact on U.S. GDP. Energy
economist James Hamilton reported these lags fit the experience of past
shocks, including the OPEC-induced recessions of the 1970s. Among other
factors, the unwinding of an involuntary buildup of autos and other durables
is a key determinant of the lag structure involved. It has also been found
that a similar lag structure holds for the impact of large declines in oil
    The virtual collapse in oil prices to US$12 a barrel in 1986 was a key
driver behind a rebound in U.S. economic growth to a four per cent-plus pace,
even in the face of mounting financial costs from the savings and loan crisis.
    "Given that oil prices really took off in the third quarter of last year,
after several years of more gradual increases, we should expect to see its
maximum hit on the economy right about now," adds Mr. Rubin. "By the same
token, however, the impact from the even larger decline in oil prices over the
last two quarters should give its maximum boost to the economy over the next
six months.
    "If triple-digit oil prices are what started the recession, then $60 oil
prices are what will end it."
    The complete CIBC World Markets report is available at:

    CIBC World Markets is the wholesale and corporate banking arm of CIBC,
providing a range of integrated credit and capital markets products,
investment banking, and merchant banking to clients in key financial markets
in North America and around the world. We provide innovative capital solutions
and advisory expertise across a wide range of industries as well as top-ranked
research for our corporate, government and institutional clients.

For further information:

For further information: Jeff Rubin, Chief Economist and Chief
Strategist, CIBC World Markets at (416) 594-7357, jeff.rubin@cibc.ca; or Kevin
Dove, Communications and Public Affairs at (416) 980-8835, kevin.dove@cibc.ca