Surging Oil Prices Could Derail Recovery

Consumers don't have to be reminded of the power of skyrocketing gasoline prices to let the air out of an economic recovery, no matter how weak. They see it everytime they pull up to the gas pumps.

In the last week gasoline prices have surged 20 cents a gallon, following oil prices higher as political violence and instability spreads across the oil-producing Middle East.

As energy prices rise, consumers must spend more to keep their vehicles running and have less to purchase other things. They aren't alone. Businesses also have to pay higher fuel costs, and may put off investments or hiring.

$100 oil

The Wall Street Journal quotes an official of the International Energy Agency as saying if oil averages $100 a barrel this year - it's about $97 now - the U.S. will pay an extra $80 billion more this year for imported oil than it did last year.

With so much money used to pay for oil and gasoline, how can the economic recovery continue. Maybe it can't.

"There is no question that higher oil prices would put a damper on what recovery we are currently experiencing, but it is also important to note that a rise from current levels of $3.17 a gallon to $3.75, while painful, isn't huge in percentage terms," said Steven Kyle, a professor of economics at Cornell University. "Even a rise to $5 - which could be quite painful in the short run and would indeed retard growth - is only 25 percent higher than the $4 levels we experienced in previous peaks."

Good news and bad news

Despite the short-term pain, Kyle sees both good news and bad news over the long haul.

The good news is that even though governments may be unstable in the Middle East, they will need the money so they will continue to export the oil. Thus, barring any concerted effort to wreck oil infrastructure such as what has occurred in past Gulf wars, any new government will resume production in short order if it even gets interrupted at all.

"The bad news is that we are looking at a long-term rise in oil prices regardless of these short term perturbations," Kyle said.

For example, suppose the economy manages to grow despite the hike in oil prices. As economies grow, they need more oil. As demand increases, so does the price. We only have to look back to 2008 for an example.

History repeating itself?

In the spring of 2008 the price of oil rose rapidly because of increasing demand from the developing world, primarily India and China. But as the price rose to $147 a barrel in July of that year, and gasoline averaged more than $4 a gallon, the U.S. economy, already in a recession, slowed considerably. It wasn't until the economic crisis of October 2008 that oil prices began to plunge.

"The moral of the story is that we, as a nation, should take steps to cushion the foreseeable effects of higher oil prices," Kyle says. "We will be glad we did when oil prices eventually surpass even levels that right now make us all unhappy."