“Is today's pain at the pump tomorrow's barrier to recovery?” asks J.P. Morgan Funds’ Market Strategist Andrew Goldberg. There is a precise quantitative relationship between changes in energy prices and economic growth, with high oil prices impacting GDP. The longer answer to the question is at this moment still uncertain. There are good arguments on both sides regarding the future direction of the price of oil, and hence the duration of pain at the pump and how it could affect the strength of continuing recovery of the US economy.

In terms of how an increase in oil prices poses a drag on GDP growth, J.P. Morgan’s own research has been able to quantify the interaction. As Goldberg notes, this research “Suggests that every $10 increase in the price of a barrel of oil can cause a 0.2% decline.”

Beyond this linear relationship, the size and speed of the increase appears to matter too. Rapid jumps in price seem to have some sort of behavioral effect, with consumers making changes to their spending patterns once prices at the pump become “salient.” That is, a dramatic increase is more likely to make consumers take notice of the pain and react.

Less clear is where the price of oil is headed—and hence how planners should play the situation. The threat that Iran could close the Straight of Hormuz and the boycott of Iran have driven prices upward. But Saudi Arabia has promised to pump more oil in response to bring prices down. Economists and planners therefore need to include many factors in their forecasts, including not just the possibility of a crisis, but also the likely reaction to a crisis including under what circumstances the strategic petroleum reserve would be tapped.

The U.S. Senate held hearings in January about the high price of oil, and the U.S. and global energy outlook for 2012. One safe conclusion reached by the hearings is that there is “a wide spectrum of potential outcomes” for oil and gas markets in 2012. Demand and global growth remain lower than before the financial crisis according this testimony. But at the same time, spare production capacity—most of it centered in Saudi Arabia—is also lower than before the financial crisis, leaving world oil markets with fewer “shock absorbers” in case of a crisis or even a threatened crisis. The outcome of the tension between these offsetting drivers of price is hard to know—at least for those without uncanny political insights.

The good news presented in the hearings is that U.S. oil production is actually increasing, a trend sometimes referred to as “The Great Revival.” This is driven by high prices, but also by new technology, the “oily” equivalent of new gas production from fracking, according to the testimony. An increase in domestic production could completely change the economic equation regarding oil. But as with shale, there are environmental concerns. Considering the unstable situation in the Gulf and potential strictures to production in the U.S., it seems that when it comes to the future supply of oil, politics is everything.

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