from Follow the Money

Oil and the US current account deficit

October 13, 2004

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Oil above $50 a barrel is not good for the U.S. trade balance. Higher oil prices are a tax on US consumers, with the proceeds pocketed by oil exporters. If oil stays above $50 in November and December, the U.S. current account deficit is more likely to be $650 billion in 2004 (5.5% of GDP) than the $615 billion Nouriel and I forecast in August. Indeed, based on the Q2 current account numbers and the current oil price, $650 billion may be a bit too low. A 5.7-5.8% of GDP deficit is not out of the question, given that the quarterly q2 deficit was 5.5% of GDP. Oil is a bit more expensive now than it was then, and at least in q3, US consumption growth seems to have been strong -- so it hard to see much of a fall off in non-oil imports offsetting the rising oil bill.

US imports of petroleum and petroleum products are likely to be around $180 billion in 2004, assuming oil stays at around $52 til the end of the year -- up from $129-130 billion in 2003 and $100-101 billion in 2002. That mostly reflects the rise in the annual average oil price from $26 a barrel in 2002 to $31 a barrel in 2003 to $42 a barrel in 2004 (I am using sweet light crude/ WTI as a proxy for oil import prices -- actual US imports include some heavier, creaper grades and thus cost less that the market price for sweet light crude, but all the price of all grades of crude tends to rise when WTI/ sweet light rises). Since oil was a lot lower at the beginnning of the year than it is now, the full impact of $52 a barrel oil -- assuming that recent price spike is sustained -- on the current account won’t show up til 2005. It is no wonder that analysts like Stephen Roach are starting to get worried.Let’s look at 2005 in more detail. A $10 barrel increase in the price of oil -- say from an annual average of $42 a barrel in 2004 to $52 a barrel in 2005 -- is likely to increase the US oil import bill by about $50 billion (around 0.4% of GDP). This forecast assumes US oil import volumes grow by 5% -- their current pace -- as a result of continued US demand growth and perhaps some slight falls in US production, but the volume effect is small. That implies an estimated 2005 oil import bill of $232 billion, by my calculations. Ouch. That would be an increase of $52 billion from my 2004 forecast, $103 billion from 03 levels, and $131 billion from 02 levels. Of the $131 billion increase from 02 levels, $113 billion comes from the doubling in oil prices (from roughly $26 to $52 billion), and $18 billion from growing import volumes.

That also puts the 2005 current account deficit -- again, assuming US growth remains strong -- in the 6.5% of GDP range or more range, since the impact of oil will be combined with, in all probability, a growing non-oil trade deficit and a rising interest bill on the growing stock of US external debt. See Stephen Jen’s piece in the Morgan Stanley global forecast. Jen is not worried about deficits of this magnitude. I am. But even Jen is worried that others will start to get worried, undermining his dollar forecast.

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