Sunday, October 28, 2007

$90 Oil Prices: Is This a New Record in Real Terms?

AP reports:

With the recent gains, the price of oil is closing in on the inflation-adjusted highs hit in early 1980. Depending on the adjustment, a $38 barrel of oil in 1980 would be worth $96 to $101 or more today.

Should we inflation adjust using the GDP deflator or the CPI deflator?

James Hamilton does the latter in a chart entitled dollar price of West Intermediate divide by ratio of CPI. By this measure, we are not yet an inflation adjusted record. WRTG Economics has their own historical price in real terms though 2006. The inflation-adjusted real price record in terms of 2006 dollars was less than $70 per barrel. I suspect WRTG Economics is using the GDP deflator, which has not risen as much as the CPI deflator since 1980. AP was not kidding when they said “depending on the adjustment”. I get the $101 figure if we use CPI but where does the $96 dollar figure come from? The GDP deflator in 2007QIII were only 2.29 times the GDP deflator as of 1980QI so wouldn't the inflation-adjusted oil price been $87 not $96 dollars?

Of course, it also matters which measure of the spot rate one uses for this. WRTG also reports both the WTI spot price and Brent Spot price, which was considerably lower.


Doug said...

It doesn't matter. High oil prices are here to stay and will only get higher.

BruceMcF said...

GDP deflator for crude oil, CPI inflator for impact of gasoline prices on consumer budgets.

And on a side note, darn, $101/barrel was so easy to keep in mind to throw out in a lecture.

Also bear in mind whether the price is Brent Sea or West Texas Intermediate ... they had been persistently "close" for a long time, but its easier to bring oil into the West Texas pricing point than to bring it out again, so the trouble with downtimes in upstream refineries has resulted in a much broader gap.

Anonymous said...

Given that (London) International Petroleum Exchange* did not exist until 1980 with trade in Brent crude oil futures beginning in 1988, and that the New York Merc (NYMEX) did not open its WTI futures until 1983, there is - unless one believes trade in paper barrels accurately captures fundamentals - a certain apples and oranges quality to then and now price comparisons. Which is not to say that pre-futures pricing was efficient, only that we are talking about distinct price formation regimes with the present one more open to speculative pressures.

*My recollection is that the IPE was initially founded in 1980 by a collection of oil and financial firms. IPE was acquired by Atlanta based InterContinental Exchange (ICE) in 2001, a global electronic trading platform which itself was founded by large financial and energy cos. a few years earlier. said...

Oil peaked back then at just over $40 per barrel in March, 1981.


BruceMcF said...

there is - unless one believes trade in paper barrels accurately captures fundamentals - a certain apples and oranges quality to then and now price comparisons

... the comparison is between the price of barrels of oil ... not between price formation regimes. Provided its the same grade of crude, the apples to oranges part of the comparison is the purchasing power of the currency used to price the crude oil, which is what the price indices attempt to correct for.

Anonymous said...

The comparison in the post is, as you say, one of price adjustments but so long as we're speaking of price, the means through which it is formed plays a part.

Price change is not simply a function of purchasing power of this or that currency but in case at hand also then and now differences such as between a regime of oligopoly + cartel and one in which trade in paper barrels, futures and options, makes the price.

As previously noted, one can take the position that the latter, the paper trade, efficiently captures present/future real conditions -- or one can understand that speculative activities have and do take place and that these constitute a different type of distortion than that of the previous arrangement.