Oil Intensity: Why Oil Prices Sometimes Come Down

For the first time I can remember, people are concerned that the price of oil may be too low. This may sound like good news, but if you read the story I wrote during the summer about Texas, you know that a significant drop in the price of oil isn’t good news for everyone. 

WTI (West Texas Intermediate) crude oil traded for about $107 per barrel during the summer of 2014. By winter that number had dropped by 50%. Many blame inflation for the change, but that’s not all there is to it. 

Let’s back up for a minute. In dollars (not counting inflation, the average price of WTI crude oil has flucuated by close to 50-fold between the years 1970 ($3.35/barrel) and 2014 ($133.44 in 2008). This fact is based on misleading data. 

First, let’s talk about inflation. 

The low inflation rates during recent years led to minor yearly devaluations. Compare this to the 70s and 80s when inflation rates hit double digits. A dollar in 1970 was worth approx. $6 in today’s money. Ten years later that dollar was worth a little less than $3. In the year 2000, it was worth even less. 

A barrel of oil traded at about $108 (in today’s money) in 1980. The value has continued to fluctuate ever since. 

The second factor affecting oil price is often overlooked. The term “oil intensity” refers to the importance of oil in Western economies. This measure is calculated by dividing national oil consumption by GDP. Oil intensity started to decline in the early 70s and has only continued to do so since. 

What have we done to lower oil intensity? 

We don’t use liquid fuel for electricity, we inject powdered coal into blast furnaces, we raised the corporate average fuel efficiency, we lowered kerosene consumption in jet engines, we made thousands of industrial processes more efficient … in other words, we’re living green! 

To put it into numbers: the amount of oil needed by the U.S. economy to produce a dollar of GDP in 1985 was only 70% of what it was in 1970. The rate continued to fall and by 2014 was 62% lower than it was in 1970. 

When you take both oil intensity and inflation into account, you can see that the rise of the price of oil during the 70s and early 80s was unprecedented. Comparatively, the fluctuations in the price of crude oil have not been as extreme as they could have been in past 30 years, especially given the instability in the Middle Each and the emergence of energy hungry nations, like China and India.