Energy crisis and oil prices
We are in the middle of a – hopefully short-lived – energy crisis. If it lasts, aggregate supply will be lower than aggregate demand in the coming months. This is what was called disequilibrium in the macroeconomic theory of the 1980s.
Disequilibrium is an ugly word: it implies quantity rationing for firms, queues in the street, lack of food in the stores etc. A disequilibrium situation isn’t a temporary equilibrium situation. Disequilibrium lasts for a considerable time, say a couple of quarters.
Fortunately, prices move faster than quantities, and markets tend to equilibrate. But while they do so, prices move so fast that the price of quick equilibration is high inflation. Given that January price hikes have already added at least 5-6% to monthly CPI – this doesn’t include spill-over effects that will spread to February – an annual ‘official’ CPI of 50-60% is in the cards.
Given such high inflationary momentum, an energy shock can only add insult to injury. It will be automatically translated into inflation either through the quantity channel (lower supply so demand exceeds supply) or directly through the price channel (higher energy prices cause higher inflation).
D-PPI (producer prices) closely follows two variables: the exchange rate and the price of oil. The impact of the price of oil is less persistent. Hence, if energy prices go up fast and drop fast the net effect would be much less than the impact of a similar exchange rate shock. The exchange rate effect is stickier.
According to many energy analysts, of which the famous James D.
Hamilton is not the only high-brow example, oil prices were kept stagnant at around USD100/barrel for almost 9 years because China and the rest of the developing world had high demand, supply was quasi-fixed, and to equilibrate the market the developed world had to cut back its demand for oil.
The pivotal mean-reversion points according to an application of the Vasicek model I used for oil mean-reversion pointed to USD108 and USD85 in 2009. This is a long-run equilibrium oil price estimate. It was in line with the estimates of some leading investment houses – but not all.
After 2013, when the U.S. fracking revolution cut the price of oil drastically by pushing American production up by 3.5 million barrel/day, global energy prices fell. It seems oil prices will hit USD 100 this year and stay there. We are back to square one, again.