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Macroeconomic modeling and rising oil prices
Vinay Gupta, 7 Aug 05

Earlier today I found myself wondering about how rising oil prices will impact the global economy. I was interested in details: how, for example, the relative prices of oranges and bananas might be changed, based on their respective oil inputs. This might seem like a dumb question, but these kinds of differential price changes could be really important in understanding the post-cheap-oil world.

There is some macroeconomic modeling data available, but it discusses prices of only $35 per barrel, and the only study I could find from the IMF examines price hikes of only $20. So my questions are: does the kind of highly detailed data I'm looking for exist, and what do the macroeconomic modeling tools predict for sustained prices of $50 a barrel and beyond?

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I have a suspition that, as a non-specialist, I may simply not have known the right search terms to extract the data I was looking for, and I'm hoping that someone more expert will be able to contribute! Also, sorry I haven't been posting much of late: my personal life contines to be a struggle. VG.

Posted by: Vinay on 7 Aug 05

Hang in Vinay, we're rooting for you!

An interesting issue that economists are now discussing is that the recent increase in oil prices is a "demand" shock, in a macro-economic sense, as opposed to a "supply" shock like almost all past price increases.

I have seen some dicussion of $65USD price levels modeled as a demand shock, and the conclusion is- wait for it- generally positive! Let me see if I can find the links...(no promises- way busy here too!).

Posted by: j david on 8 Aug 05

some claim this demand shock is short-term due to the lag for infrastructure development to increase output capacity beyond current thresholds.

I hope one of the 1st things to change would be the unncessary exchange and transport between distant countries who trade with each other in similar commodities. I thought of a 'goods clearing house' service that avoids unnecessary shipping by replacing substitutable commodities in kind from local/nearer sources (instead of shipping the actual commodities from a far-away place). All very complicated & probably unworkable, but so is the current system

on yr question Vinay, Lester Brown has spoken recently about this exact same affect, not from oil but water: from the supply shortage v's increasing demand for water. ie we purchase food that used x litres of water in its production & processing. So the richer people will be able to accommodate increasing food prices taking up a larger portion of their budget, but tough for people who already spend most of their income on food.

connecting the 2 areas: oil-derived fertilizers make crops more thirsty...

Posted by: Janelle on 8 Aug 05

I'm not sure how strong the bridges are over the gap between assessing the likely macro outcomes and assessing their likely impact on micro events like local goods markts.

Not the specific answers you asked for, but these might interest you:

The Impact of Higher Oil Prices on Low Income Countries and on the Poor March 2005
by the UNDP & world bank

Why Our Food is So Dependent on Oil

there's a bit out there if you search, say oil impact + “increasing (or higher) food prices” or oil + inflation + “food prices”

Posted by: Janelle on 8 Aug 05

Good question, Vinay. This came up recently in the course of discussions with friends, when we started thinking about more detailed impacts of rising oil prices.

We quickly realized that it would be nice to have a vector of multipliers that summarizes how much an x% increase in oil prices will increase the price of other commodities - e.g. a multiplier of 0.5 for grain would mean that a 20% increase in oil implies a 10% increase in grain prices.

This "vector" is actually a matrix or more complex data structure, due to all the nonlinear effects, varying substitutability of commodities at various prices, differences between locales, and so forth. But thinking of some rough multipliers is easy to work with and explain.

(Substitutability might be the biggest unknown and challenge for all of us. How much can demand be reduced or diverted to low resource-use options? There's some economics work on "demand elasticity" which may be relevant.)

Even a rough idea of which areas have high multipliers will help pinpoint which areas are most problematic. And more precision would allow informed policies to be developed.

Posted by: Hassan Masum on 8 Aug 05

We quickly realized that it would be nice to have a vector of multipliers...

Indeed it would, Hassan, tho I suspect that the non-linear effects would make it hard, as you say, to model with any predictive accuracy.

OTOH, this may be another case (like dealing intelligently with the EU product directives) where precision is less important than the direction of the vector. We're advising clients to at the very least invest in a bit of contigency planning for the possibility of high (or very high) energy prices -- and that means understanding the vulnerability of commitments to processes, products and supply chains that represent hig embodied energy.

OTOOH, who benefits and who loses may not always be what you think; S&P's chief economist said last year that because 'energy is a much smaller part of the U.S. economy than it was during the first and second OPEC crises...Even at $75 a barrel, we wouldn't see a recession in the U.S.'.

OTOOOH, I'm wondering what happens at $100.

Posted by: Gil Friend on 8 Aug 05

Actually, I remember something along these lines actually exists: I came across it when I was working on a whitepaper for RMI:

Here's the relevant page:

The "Economic Input-Output Model for Environmental Life Cycle Analysis" by the Carnegie Mellon University Green Design combines a variety of U.S. government data on environmental impacts and economic interdependencies. Researchers can use the model to calculate the total cumulative environmental and economic impact of economic activity in some 485 different economic areas, such as "Commercial Fishing" or "Air Freight."

For example, the EIOLCA simulation reports that $1 million of spending on "book printing" (one of its 485 economic categories) will release 4.3 million metric tons of CO2. All the different emission sources for each economic category are shown individually, so it is clear that "paper production" and "transport" account for almost half of the emissions in the book printing process.


And, well I'll be a brass monkey, but they have a nice web site. I bet there's a way to tweak the underlying model for different oil prices (I bet oil is one of the vectors in the system already, possibly processed down into oil, gasoline, diesel etc- it's pretty detailed). Have fun!

Posted by: Vinay on 8 Aug 05

Gil wrote:

"OTOOH, who benefits and who loses may not always be what you think; S&P's chief economist said last year that because 'energy is a much smaller part of the U.S. economy than it was during the first and second OPEC crises...Even at $75 a barrel, we wouldn't see a recession in the U.S.'."

One needs to be careful with this line of thought. During the 70's, many economists argued that energy had little relevance to the economy because "the energy sector is only 8% of GNP" (GDP these days). To which some of us replied, "Yeast is much less than 8% of the bread, but without it, the bread stays flat. Vitamin D is much less than 8% of your body mass, but without it, you die. If the atmosphere in the room reaches 8% carbon monoxide, you're goners."

We all have a tendency to see relationships as linear and arithmetic, instead of nonlinear and exponential. You hear this stuff all the time. Trucks can't be causing all the road damage, they're only 15% of the vehicles. You could put all the people on Earth on less than 2% of the world's land area and still give everyone 1/4 acre (or something about that order of magnitude). Aluminum is the second most abundant element in the Earth's crust so resource scarcity will never be a problem. (By that reasoning, since hydrogen is the most abundant element in the universe, energy will never be a problem.)

I know that Gil doesn't think like this, and I'm sure he knows that, in real money terms, $75-a-barrel oil is cheaper than oil in 1979. I just wanted to seize on the contention that something isn't important when it's a small percentage of something else, or vital just because it's a large percentage. That's a thought trap to avoid.

Posted by: David Foley on 9 Aug 05

Hm. Right now there are so many reasons for economic slowdown it would be hard to pick out Oil Price from National Debt, Personal Debt, echos of the Dot Com Bust, creeping fear, and all the rest of it.

That said it really disturbs me that the global macro stuff doesn't appear to have been run, and results published, for $60, $80, $100 a barrel prices. I'm sure there would be a great story in this for some enterprising journalist.

Posted by: Vinay on 9 Aug 05

I asked the same question too. What is the impact of high oil prices on food?

Well I did some general internet surfing and came up with 39% for material, i.e., like plastics and oil base materials (fertilizers for food too?). Manufactured or packaged items, like food stuff, comprise about 16-22% oil costs. That means if oil doubles, food goes up about 15%. Housing materials should too.

Posted by: Softwarengineer on 11 Aug 05



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