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Economic SYNOPSES short essays and reports on the economic issues of the day 2004 ■ Number 18 A Crude Crude Oil Calculation James B. Bullard key macroeconomic development during 2003 and The question is, should we expect this price level to be 2004 has been the higher price of crude oil. Analysts sustained? have attributed the higher price to several possible One way to answer this is to consider the futures market sources, including supply disruptions in key oil-producing prices for this commodity. The December contracts for 2004 countries, demand increases from a global economy perthrough 2008 stipulate an expected future price, which we forming better than expected, especially in Asia, and a risk can then convert into 2004 dollars by guessing an expected premium associated with an uncertain security environment rate of CPI inflation in the U.S. over the life of the contract. in the Middle East. Oil prices have a long and checkered The University of Michigan monthly survey of household history in U.S. and global macroeconomics, with some expectations suggests this longer-run expected inflation rate analysts going so far as to associate every postwar U.S. recesis currently about 3.0 percent, and we will assume it is consion with sharp increases in oil prices. In this context, it is stant through December 2008. The diamonds in the chart important to try to assess the impact of the present episode. indicate the real price of crude oil expected in futures marHas the recent price behavior in this market changed signifikets according to this measure. The calculation suggests that cantly from what it was over the previous 15 years? the price of crude oil will return to its 1988-2002 mean The chart shows the monthly average price of a barrel gradually over the next several years. By this measure, the of West Texas intermediate crude oil from 1988 through market does not foresee a substantially higher long-run June 2004, deflated by the U.S. consumer price index real price of oil. ■ (CPI) to obtain the price in constant 2004 dollar terms. The mean plus and minus two raw stanReal Oil Prices dard deviations of these prices, calculated from Monthly Average of Daily Data 1988-2002, are indicated in the chart. The twoOil Price, in Constant 2004 $ standard-deviation rule of thumb is one simple 60 way to separate unusually large movements from ordinary fluctuations. Prices consistently outside the two-standard-deviation band might 50 indicate that the market has undergone some type of structural shift and that the inflation40 adjusted mean price might be substantially higher in the future. 30 The chart indicates that, as a first approximation, this market displayed a constant mean price of about $27 per barrel in 2004 dollars through 20 the period 1988 to 2002. Since 2002, the real price has increased, recently moving outside 10 the two-standard-deviation band. This price is higher than any observed since 1988, except for Mean +/– 2 Standard Deviation Futures Prices as of June 2004 the brief period of $50-per-barrel oil during the run-up to the first Gulf War. So even taking norNOTE: Mean and standard deviation are from 1988-2002. mal volatility into account, today’s prices are high. 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 A Views expressed do not necessarily reflect official positions of the Federal Reserve System. research.stlouisfed.org