World Oil Recessions

December 12, 2008
The total economic activity of a country is referred to as its Gross Domestic Product (GDP).  Aggregating the annual GDP for each country yields total world economic activity, which is usually referred to as Gross World Product (GWP).  When the economy of an individual country experiences a contraction, a period when GDP actually declines, it is called a recession.  Since the tracking of total world economic output began, there has never been a year in which GWP declined.  GWP grows at an average rate of about 3.5% annually.  Since GWP has never been negative, a global recession is generally defined by economists as GWP dropping below a 2 - 2.5% annual growth rate for one or more years.

When oil prices rise rapidly or supply interruptions occur, as has happened several times since 1971, the U.S. economy usually falls into a recession within a fairly short period of time.  Just as the U.S. economy is directly tied to a steady supply of cheap imported oil, the world economy also requires oil price and supply stability in order to maintain economic growth trends.  The global economy falters during oil shocks and it is not a coincidence that the four times since 1971 a global recession has occurred it was preceded by a rapid rise in the price of crude oil.  Because of the diverse nature of economies around the world, it often takes a year or more before the full impact of an oil price shock takes effect and slows GWP growth sufficiently to cause a world oil recession.

The 1973 Arab oil embargo caused the first world oil recession, which began in 1974 and lasted for two years.  In less than a year, limited supplies and OPEC price increases caused oil prices to quadruple, rising from about $3 a barrel to over $12 a barrel.  It was a relatively mild global recession with GWP growth barely dropping below 1.5% in 1975 and quickly recovering in 1976 as oil prices remained fairly stable and economies around the world adjusted to the new price levels.

The second global oil recession began in 1980, again after crude oil prices rose rapidly.  The initial oil price spike was due to a decrease in supply caused by the Iranian revolution.  Oil prices rose from below $15 a barrel in January of 1979 to over $30 a barrel in January of 1980 and then to over $38 a barrel in February of 1981 after the onset of the Iran-Iraq war.  It was by far the most severe global recession, with growth slowing to 2% in 1980 and falling below 1% in 1982.  The recession lasted for three years and ended after oil prices stabilized and then began to fall in 1982 and 1983 in response to significantly reduced worldwide demand.

The third world oil recession began in 1991 and lasted for three years.  It too started after oil supply disruptions and rapid price increases, this time caused by Iraq's invasion and subsequent occupation of Kuwait.  Oil prices fluctuated between about $12 and $20 a barrel throughout 1988 and 1989, which decreased GWP growth to under 3% in 1990 after several years of above average growth.  Oil prices increased from under $15 a barrel in June of 1990 to over $31 a barrel in September of 1990.  Even though prices fell back to under $20 by February of 1991, the damage was already done and GWP growth fell to 1.5% in 1991 and only rose to 2% during 1992 and 1993.  Average GWP growth returned in 1994 after oil prices dropped from about $20 a barrel in 1992 to about $12 a barrel in 1993.

A fourth global oil recession started in 2001 and only lasted one year.  It was by far the mildest global recession with GWP growth not even falling to 2% after oil prices rapidly rose from under $10 a barrel in January of 1999 to over $30 in September of 2000.  Tight supplies caused by OPEC production cutbacks intended to increase prices were the cause of the oil price increase.  GWP growth quickly rose to above average levels in 2003 after oil prices dropped back to about $15 a barrel in 2001.

By all rights, another world oil recession probably should have started in 2007 or 2008, after the slow and steady increase in oil prices from under $20 a barrel in 2002 to nearly $70 a barrel in 2006.  Part of the reason GWP grew at well above average rates from 2004 to 2007, even in the face of rising oil prices, was that prices did not rise too rapidly and gave economies around the world more of a chance to adjust.  However, the main reason was that developing countries, especially India and China, and oil exporting countries experienced unprecedented economic growth during that time.  That unprecedented growth was fueled by massive transfers of wealth from Western countries that were experiencing asset bubbles in housing, commodity, and stock markets purchasing imports.  Those asset bubbles have all now burst and demand for imports has declined significantly.

The fifth world oil recession will almost certainly begin in 2009, though it is possible that sheer momentum will be able to keep GWP growth above 2.5% and delay the start until 2010.  The severe damage inflicted on economies around the globe by the huge oil price shock experienced in 2007 and 2008 helped to cause the asset bubbles that had been feeding demand for exports from developing countries to burst rather than slowly deflate as they might have under normal circumstances.  Without those asset bubbles to support imports of their products, developing countries will no longer be able to sustain the high economic growth rates they had been enjoying and GWP growth will fall dramatically.  Another global oil recession is assured; the only unknowns are when it will start, how severe it will be, and how long it will last.