Do you remember the great oil shock of 2008?

New research aims to answer an enormously important question: Did the laws of supply and demand cause energy costs to surge, or was it something more nefarious?

Published April 3, 2009 10:00AM (EDT)

Before the all-consuming economic crisis transfixed the world's attention, we spent quite a lot of time at this blog arguing about what caused the great oil price spike of 2007-08. Many How the World Works readers were (and probably still are) convinced that normal laws of supply and demand could not possibly explain either the drastic rise in the cost of oil or the equally precipitous crash. Speculation and/or market manipulation had to be the real culprit.

This is an important question to answer, because if speculation is at fault, then perhaps political energy is better spent trying to modify market behavior than develop alternative sources of energy. But if the real problem is that global demand is outstripping supply, then there is no time like the present to get serious about conservation and energy efficiency and renewable energy. With a major political battle looming over new energy legislation set to play out over the next year, against a backdrop of cratering investment in clean energy technologies, the stakes could not be higher.

Into this quagmire bravely treads U.S. San Diego economist James Hamilton, who presented the 70-page paper "Causes and Consequences of the Oil Shock of 2007-08" on Thursday at the Brookings Institution. Hamilton summarizes his conclusions on his blog here and it is a must-read for followers of this topic.

Two key quotes:

World real GDP increased by 9.4 percent between 2003 and 2005. That growth in world income was the primary cause behind an increase in world petroleum consumption of 5 million barrels per day between 2003 and 2005, a 6 percent increase over the two years. The next two years (2006 and 2007) saw even faster economic growth (10.1 percent cumulative two-year growth), with Chinese oil consumption alone increasing 870,000 barrels per day. Yet between 2005 and 2007, global oil production stagnated...

And the bottom line:

But while the question of the possible contribution of speculators and the Fed is a very interesting one, it should not distract us from the broader fact: some degree of significant oil price appreciation during 2007-08 was an inevitable consequence of booming demand and stagnant production. It is worth emphasizing that this is fundamentally a long-run problem, which has been resolved rather spectacularly for the time being by a collapse in the world economy. However, the economic collapse will hopefully prove to be a short-run cure for the problem of excess energy demand. If growth in the newly industrialized countries resumes at its former pace, it would not be too many more years before we find ourselves back in the kind of calculus that was the driving factor behind the problem in the first place. Policy-makers would be wise to focus on real options for addressing those long-run challenges, rather than blame what happened last year entirely on a market aberration.

Hamilton's paper deserves the rare honor in my household of getting printed out on real paper, because few topics merit closer study than the future of oil prices. The Republicans are already claiming that passing any kind of energy bill with teeth in a recession is foolhardy -- but if we come out of this recession without having prepared for the high oil prices that are inevitable as soon as economic growth resumes, then we're going to be even worse off in the near future than we were last summer, and we run the real risk of having any economic recovery choked off by spiking energy costs.

Meanwhile, while Washington bickers, China decides it wants to dominate the world's market for electric cars. Sometimes, it just pays to be a ruthless totalitarian dictatorship.


By Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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