Oil Prices Can't Be Wished Lower

The first oil shock -- in the 1970s -- produced fear and anger, both of which derived from the sudden awareness of our vulnerability. Then the price fell for a few years until the second oil shock, associated with the Iranian Revolution and the Iran-Iraq War, which produced a surge to the highest inflation-adjusted petroleum prices ever. By 1986, the price collapsed, and after a brief rally in 1987, collapsed again to low levels.

The third oil shock wasn't a supply shock at all but rather a self-inflicted buying panic produced by uncertainty over Iraq's invasion of Kuwait and the impending war. Prices fell and remained low all the way into 1996, at which point a mild rally appeared and disappeared. The downturn in demand associated with the Asian and Russian crises of 1997-98 put prices down to their lowest inflation-adjusted prices ever by February 1999.

The fourth shock, also associated with Iraq, took place this winter during the buildup to the second Iraq war. Given the recent history and the prospect that a quick and convincing victory would assure the U.S. of a secure supply of oil, many assumed we would see a repeat collapse of oil prices.

That collapse didn't happen and, given the various indicators on display, isn't likely to happen for the foreseeable future. The high tax on the global economy represented by high oil prices will remain. Whether this is sufficient to either keep the global economy on a slow growth path or push it back into a global recession is indeterminable, but higher oil prices are never a positive for global growth.

Some Quantitative Indicators

First, let's update some of the indicators presented here last January, the last time I addressed the global oil market. The ratio of implied volatility to high/low/close volatility in the crude-oil market gives a good measure of the extent to which traders are willing to buy insurance against adverse price moves. Whenever this ratio falls toward 1.00, it indicates relative comfort with the prevailing trend.