On The Road To $100 Oil: The Historical High Is Actually $99.04 Per Barrel

With eyes focused on whether and when oil breaks through the $100 barrier, it turns out that $100 a barrel is really $99.04, at least in terms of the all-time record, according to Cambridge Energy Research Associates (CERA).

CERA, an IHS company (NYSE: IHS), finds that the inflation-adjusted high of $99.04 in today's dollars, $39.50 in 1980 dollars, was reached during the spring of 1980 when geopolitical turbulence in the Middle East, and Iran in particular, created acute uncertainty about the reliability and adequacy of oil supplies from the world's most important oil exporting region.

"Breaking the historical high of $99.04 per barrel will be a landmark in itself," said James Burkhard, managing director of the Global Oil Group at CERA. "It will certainly have psychological impact since it will intensify momentum for the market to hit $100 per barrel. And it will have a concrete effect since it pushes the world economy deeper into uncharted territory-the oil price range which can contribute to an economic slowdown."

CERA's calculation of $99.04 is based on the April 1980 nominal average posted price of $39.50 per barrel for West Texas Intermediate. This is a monthly average price since, at the time, there was no crude oil futures market to provide a daily price. Crude oil futures trading did not begin until 1983. The translation of the nominal prices into 2007 U.S. dollars is based on the U.S. Consumer Price Index using annual averages.

"There are different indexes and methods that can be used to adjust prices to inflation," Burkhard said. "These methods can result in prices that are lower or higher than our $99.04 per barrel calculation. However, we believe that using an annual average inflation rate provides the best basis for comparison between 1980 and 2007, and that is what makes $99.04 the benchmark for today."

$100 OIL: WHAT IT MEANS

The oil price in recent weeks has taken on the trappings of a sporting record that once seemed untouchable. Now it is broken with such regularity that what has historically been viewed as a distant prospect-$100 per barrel oil-is in sight. The world has never experienced a triple-digit oil price. The all-time inflation-adjusted high was in April 1980, when, CERA calculates, crude oil hit $99.04 per barrel in terms of 2007 US dollars. The broader significance of a $90-$100 price range is that it highlights in dramatic fashion how different the oil market environment, and indeed the world economy, is today compared with the past two decades.

Daniel Yergin, chairman of Cambridge Energy Research Associates, made the following statement with regard to the rising price of oil:

"The oil market is demonstrating both 'fright and flight.' Instead of the proverbial 'flight to the dollar' in times of economic uncertainty, we're now seeing 'a flight to oil.' The strengthening of oil since August is responding, in part, to the weakening of the dollar. For the last few years, the force behind rising oil prices has been strong global economic growth. Over the last several weeks, the market focus has shifted to economic weakness in the United States. At the same time, tension over Iran's nuclear program will continue to recharge anxiety on a continuing basis in the oil market.

Historical assumptions about the dynamics of oil prices, demand, supply, and the global economy have given way to a new, but still unfolding, paradigm. This new paradigm is not without risks and dangers. The world economy can withstand the headwinds of very high oil prices much better than in the past, but prices of $90 to $100 push geopolitics and the economy deeper into uncharted territory. High oil prices will tend to exacerbate geopolitical tensions in the short term and create a sharper divide between the winners and losers of a very high oil price environment.

Today's price levels bring us farther into the range where the oil price can contribute to an economic slowdown. The effect on economic and oil demand growth depends on the duration of $90-$100 oil. Although not widely recognized in the face of the attention on the record, for 2007 the year-to-date annual average for West Texas Intermediate is just $70- not $100.

Burkhard continued: "The reaction to oil prices varies much around the world, owing to differences in income levels, taxes, subsidies and the relative use of oil in a national economy. But, if oil prices were to average around $110 for six months or more, it would increase the world economy's vulnerability to a serious downturn of the early 1980s' type. But even prices in the $90s have negative impacts on the economy and consumer spending. We just haven't seen the full effects yet, for the year-to-date annual price for oil this year has been $70- not $100!

"CERA's Break Point scenario (as described in CERA's Dawn of a New Age: Energy Scenarios to 2030 study) demonstrates that $120-plus prices would not only have major economic impact, but would lead to much stronger conservation policies among consuming countries and would greatly accelerate innovation and efficiency and a move away from oil, even in transportation."

High oil prices in the 1970s set the stage for the most severe global downturn since the Great Depression. Indeed, the high prices of 1980 were at the beginning of the worst three-year period of economic growth of the past four decades. For the oil price to potentially play a similar role in a significant economic slowdown, prices would have to average from $100 to $120 per barrel for six months to a year. To be sure, negative economic repercussions on consumer spending and economic growth will also materialize even at prices in the $90s range. Also, of course, oil prices do not exist in a vacuum, but will interact with other economic developments, particularly the unfolding consequences of the credit crunch.

The jump in price from $75 at the beginning of September to the mid-$90s in early November highlights the dominant sentiment driving the oil market-that oil supply will be unable to keep pace with rising demand. The market may hit prices above $100 unless signs emerge that the oil price has reached a level that is reducing economic and oil demand growth. However, if oil demand growth hits the brakes or if supply anxiety eases, we could see a steep fall in price.

Daniel Yergin added: "Oil prices at this level will themselves be a negative in conjunction with everything else going on in the U.S. economy. While $60 or $70 oil had little effect on the economy, that does not mean the same will hold true for $100 oil. One point is obvious - we're much more likely to see an impact on demand at this higher price level, especially in the context of a slowing economy.

"A continuing downslide for the dollar will put oil on an upslide."