Nobel laureate in economics: the price of oil may soar above $150

Krugman won the Nobel Prize in Economics in 2008 for his contribution to the understanding of international trade patterns. In his studies, he showed that trade between countries does not result only from objective differences such as climate or resources, but also from processes of specialization in production and “network effects”. Alongside this, he has written extensively on the field of “economic geography”, which explains why industries tend to concentrate in certain areas, for example Silicon Valley in the field of high-tech or central London in the field of finance, while other areas remain peripheral.

In a post he published on his blog last Friday, March 13, Krugman claimed that the fact that the recent spike in oil prices has not yet led to a significant economic crisis indicates that prices may rise much more. According to him, the current price level reflects an optimistic assumption by the markets that this is a relatively short crisis after which the oil will continue to flow as usual.

Krugman mentions that oil prices today are not much higher than the levels recorded during Donald Trump’s first term, when they hovered around $60-70 per barrel (adjusted for inflation). However, now, about 20% of the world’s oil supply is actually trapped behind the Strait of Hormuz, a major shipping route for the passage of oil from the Persian Gulf, so a price of about $100 per barrel seems to him to be low relative to the existing risk, i.e. unsustainable.

If this optimistic assumption turns out to be wrong, and the blockade continues for a long time, the supply disruption could be the most severe in decades.

The world economy will suffer

Krugman compares such a scenario to historical energy crises, including the Russian invasion of Ukraine in 2022, the Iranian revolution in 1979, the oil boycott of Arab countries in 1973 and even the Suez crisis in 1956 – but notes that in the case of a prolonged blockade of the Strait of Hormuz, the damage to the global oil supply could be even greater.

However, he qualifies and says that the modern economy is less sensitive to oil prices than it was in the past. In recent decades, the output of leading countries such as the USA has increased significantly, while oil consumption has increased at a relatively moderate rate. Despite this, he believes that the current prices do not yet reflect such a significant disruption in supply.

In the end, for him it is a basic argument of demand and supply. The oil supply is not able to respond in a short time to a disruption in supply and such a dramatic increase in price. The establishment of new oil fields requires huge capital, which is not worth investing in short-term production, therefore in such a situation the factor that will be forced to surrender is precisely the demand.

As Krugman wrote: “How high does the price have to be? High enough to convince drivers to stop driving, truck drivers to stop driving, airlines to stop flying. In other words, the price of oil has to rise enough to cause a global economic crisis, even though the world is much less dependent on oil than it was.” In his eyes, “it would have to be very ugly to get the world to buy less oil.”

He concludes that the forecasts talking about oil at a price of $150 per barrel in the event of a prolonged war in the Persian Gulf may actually be conservative. “I saw some alarmists warning that a long war in the Gulf could lead to oil at a price of $150 per barrel. That seems low to me.”