Consumption Rate of Oil

Oil and gasoline prices had been a problem since individual vehicles had actually entered the market. After the Katrina United States current economic growth is not even sustainable under the recent oil price surge. Even though the Department of Energy does not feel that oil prices are high enough to cause a recession, the consequence of high energy costs cannot go unaddressed.

Government has to start looking and actually spending money on solutions to this consumption problem immediately. This is the biggest problem driving United States economy to inflation.

It is proven by a fact that reducing the biggest consumption in the market would affect the aggregate demand graphs which would directly affect the economy negatively. So there should be other options to reduce the recession. Isn't it true that finding new energy sources to take the place of oil use would reduce this problem?

High Oil Consumption in U.S. Constraining Supply

By Joseph D. Villalon

OPEC raised the price of crude oil in world markets in 1973. During this time the price of crude oil rose 50 percent. The result was a supple shock, reduced supply of gasoline, since crude oil is the major component used to produce gasoline. Countries around the world, including the United States experienced inflation and recession.

Many placed the blame squarely on OPEC for the ensuing problems with gasoline supply, but economists have blame policymakers for limiting the price that oil companies could charge for gasoline. In time, the price of oil declined about 10 percent a year and U.S. policy makers repealed the regulatory polices it had put in place to control the price of gasoline.

The recent surge in oil prices is due to a large amount of consumption, especially in the U.S. in which 25 percent of the world's oil output is used. The increase in global oil consumption last year was the highest increase in nearly 30 years. A second reason for the rising oil price is that supplies are constrained coupled with the large consumption by countries such as the U.S., China and India.

Optimists argue that, when adjusted for inflation, oil prices are not near previous peak prices. Along with that argument is the opinion that oil is cheap and will not impact economic growth. This is a misconception when very high consumption on a sensitive supply is realized.

Higher oil prices, even though lower than previous highs when adjusted for inflation, do have an adverse effect on nearly everything. In the U.S., prices for travel, shipped goods, and services all increase with fuel prices. Consumers have to adjust what their dollars are being spent on to continue to be able to afford the high prices at the gasoline pump.

Additionally, consumers are expecting an increase in inflation rates in the coming years. Thus, consumers become pessimistic and will spend less money, a decrease in consumption, to compensate for higher energy prices. Wages are not being increased to offset the high energy prices due to the global labor market. Historically, companies would index workers' incomes to inflation and provided pay raises when oil prices increased. Imported goods are cheaper and replace American goods or leave U.S. manufacturers no choice but to keep their prices low while having to work with higher fuel prices.

Even though the Department of Energy does not feel that oil prices are high enough to cause a recession, the consequence of high energy costs cannot go unaddressed.

Oil prices can be compared to a tax on consumption. Nearly every good and service in the U.S. is dependent on oil as a fuel. From travel to shipping freights and other services, the price of energy must be included. If fuel costs rise, the prices of the product or service rise and are passed on to the consumer. Any event that might decrease consumption will affect aggregate demand by shifting the curve to the left, decreasing the quantity output and essentially the real GDP.

Currently, strong spending and an increase in fuel consumption in the U.S. -even during the recent period of higher fuel prices- has been able to offset the effect of a constrained oil supply shocked with Hurricane Katrina's catastrophic outcome and ever higher consumption.

Figure 1:

Any decrease in consumption ©, would shift aggregate demand to the left (AD1

 AD2) causing a decrease in the quantity output (Y, RGDP).

The effects of the higher oil prices is that everything will cost more, a repeating theme, thus lowering the profits of companies. Also, the task of the Fed becomes more complicated by worsening inflation and growth prospects of the U.S. economy. The most likely action by the Fed is to raise interest rates, contracting the money supply. Such a move would reduce the loanable funds available, and in use, within the housing bubble. Investors and individuals would decrease their purchases of real estate and investments in building, which would shift aggregate demand to the left. Ultimately, the quantity output (Y, RGDP) would decrease as well.

A further effect of the high oil prices will be the increased cost in home-heating as the winter months approach. U.S. oil demand usually peaks in the fourth quarter when homes and businesses buy heating oil for the northern hemisphere winter.

It is the wealth effect of the housing bubble that has allowed Americans to afford higher energy costs and to simultaneously maintain strong spending on other items. An action by the Fed to stave off inflation, and confront high oil prices by contracting the money supply, would effectively end the economic growth that has been occurring.

The U.S. domestic oil supply is very sensitive and that became evident in the wake of Hurricane Katrina. Along with Hurricane Rita, worries have developed that the world, and especially the U.S., is vulnerable to supply shocks. The amount of oil production per day that was interrupted in the Gulf of Mexico is roughly the amount that global oil producers have as spare crude-pumping capacity. An event with such an impact strains the cushion of "extra" oil that protects consumers from a supply shock.

In order to address this vulnerability, consumption, domestic supply and alternatives to energy fuels must be addressed. There is no "quick fix" in sight as the low oil prices of the 1990s led to a cut in production costs, decreased investments on further production and exploration