The drop in crude oil prices from more than $100/barrel in June 2014 to just over $30/barrel at present has been astonishing. But then, the rise in oil prices from less than $20/barrel in late 1998 and early 1999 to a peak of $125/barrel in August 2008 was pretty astonishing, too. For that matter, the fall in oil prices from more than $100/barrel in March 1980 to around $30/barrel by mid-1986 was also quite astonishing–and so was the double-barreled rise in oil prices from around $20/barrel in 1972-73 up to over $50/barrel in early 1974 and then the additional rise to over $100/barrel by early 1980.
Here\’s a chart from Macrotrends showing the inflation-adjusted price of oil going back to the 1940s. If one had to characterize the pattern of oil prices since about 1970, it would be fair to say that there are some sharp rises and falls, but not much long-term trend either up or down.
Why do these violent movements in oil prices keep astonishing us? Christiane Baumeister and Lutz Kilian tackle this question in \”Forty Years of Oil Price Fluctuations: Why the Price of Oil May Still Surprise Us,\” which appears in the Winter 2016 issue of the Journal of Economic Perspectives. (Full disclosure: I\’ve been the Managing Editor of JEP for almost 30 years. All issues of the journal, back to the very first, are freely available on-line courtesy of the publisher, the American Economic Association.)
At a political economy level, it seems to me that we are often astonished because we tell ourselves a story about the previous change in oil prices, and then we have a hard time shifting our story. For example, I\’m old enough to remember stories from the 1970s about how the iron grip of the OPEC cartel meant that oil prices would never fall again; and stories from the 1980s and 1990s about how deregulation of oil prices had broken the back of OPEC so that oil prices would be low; and stories from the mid-2000s about how the world was approaching \”peak oil\” production and oil prices would inevitably stay high. It\’s useful to remember that every story about price shifts comes with assumptions about other underlying conditions not changing–which means that such stories come with an expiration date.
Baumeister and Kilian go over oil prices since about 1970 in a much more systematic way. Here are a few of the points I took away from their article.
3) High prices for oil at one point in time will set off search for ways of conserving energy and for new energy resources. However, the outcomes of these activities are not fully predictable, and thus tend to surprise us. The oil price drop of the 1980s, for example, is in part traceable to energy conservation and new energy sources that made sense given the high energy prices of the 1970s. The hydraulic fracturing technologies for extracting oil and gas were pushed forward in response to the high energy prices of the early 2000s. These steps toward greater conservation and new technologies take an unpredictable amount of time, and when their effects arrive, it feels like a surprise.
I\’ve argued in earlier posts that I don\’t expect a shortage of fossil fuels will drive the global price systematically much higher during the next few decades. But the history of oil prices in recent decades strongly suggests that even if the inflation-adjusted before-tax price of oil in, say, 2030 or 2040 isn\’t dramatically different from today, there will be some dramatic climbs and plunges in oil prices along the way.