The Impact of High Oil Prices

The price of oil has become disconnected from the economics of supply and demand. There is a risk premium due to geopolitical events: tension between Turkey and the Kurds, a potential military strike of take out Iran's nuclear capability. We are an event or two from $100 oil.

Long term oil will go higher based on the depreciation of the dollar and continued strong growth of the world's economies. Nevertheless I believe there is a better chance that it will go lower in the short term.

The difference between former "oil shocks" is that this one is based largely on demand due to strong economic growth rather than a constraint on supply. Yesterday, oil finally surpassed its all time high from 1979 in constant dollar terms. But higher oil prices do not have the same impact on our economy that they once did. A big reason is that we are so much more productive and so much more energy efficient that we were in decades past.

There was a terrific discussion on last night's Kudlow & Company on CNBC on the price of oil and its impact. This chart is from that program. Today it takes well less than half the energy it took in 1949 to produce a dollar of GDP. It takes just over half the energy to produce a dollar of GDP than it did even 26 years ago in 1980. This is dramatic progress in terms of efficient use of energy. The result is that our economy relies far less on energy to produce GDP than we did even several decades ago.

Disclosure: at the time of this posting the author was long DVN, VLO, CCJ and short USO.