Greater U.S. Home, Other Efficiencies Help Mute Effect of Recent High Energy Costs

Special Commentary from the Office of the Chief Economist
by Frank E. Nothaft, Freddie Mac's chief economist
December 23, 2004

Energy costs moved substantially higher this past year – much higher than experts had expected. But recent high costs have disrupted the U.S. economy far less than in the past, because we use energy more efficiently. Part of more efficient energy use is the increasing energy efficiency of homes.

The culprits in this year’s energy cost run-up, which seemed relentless through October, have been many-fold. Increasing global energy demand, sparked by economic recovery in the United States and exceptional growth in Far East economies (primarily China), bumped up against renewed uncertainty over ongoing crude oil supplies. Supply concerns were fueled by conflict in the Middle East; Russia’s ongoing battle with Yukos, its second-largest oil company; last winter’s Venezuelan labor unrest; recent civil strife in Nigeria; and a slew of severe tropical weather that brought several Gulf of Mexico platforms offline. Nonetheless, oil prices have eased over the past month, and the most likely scenario is a continued gradual decline in crude prices as supply uncertainty wanes.

Crude Oil Prices Set Record in October

The price of a barrel of West Texas Intermediate hit a record of $55.23 on October 25 – almost double the $30 price just a year before. In turn, gasoline prices moved higher and took a bite out of consumer discretionary spending power. Growth in personal consumption expenditures slowed from 4.1 percent (real, annualized) in the first quarter of 2004 to 1.6 percent in the second quarter, explaining a large part of the retrenchment in economic activity and lackluster job growth of the late spring and early summer months.

Even though crude oil prices were at all-time highs in October, the effect on the U.S. economy was completely unlike that of the early 1980s. As shown in Exhibit 1, while oil prices were at record levels in nominal values (red curve in diagram below), October prices were only one-half of the 1980s peak in real values – that is, after adjusting for price inflation in other goods since then (blue curve). Thus, oil prices need to double from the October levels to be as high as they were in 1980. The fact that real oil prices are well below the 1980 level mitigates their disruptive effect on our economy.

United States Is More Energy Efficient Today

Another reason why energy prices are far less disruptive to the U.S. economy today is because we use energy more efficiently than we have in the past. Between 1949 and 1979, a period of relatively cheap energy and growing uses for it, energy consumption per person grew at a 1.7-percent annualized rate, peaking at 360 million British thermal units (BTUs) of energy consumed per capita. Between 1979 and 2003, energy consumption fell by 0.3 percent (annualized) to 338 million BTUs per capita. Fuel economy of passenger cars has also improved, rising from an average of only 14.6 miles per gallon (MPG) in 1979 to 22.1 MPG in 2002 (some of this benefit has been negated, however, by increased usage of sport utility vehicles).

Over time, houses have also become more energy efficient. New homes tend to include the latest construction technology and newer appliances, consuming less energy than older homes. As shown in Exhibit 2, annual fuel costs measured relative to home value are lower for more recently built homes, dropping dramatically for homes built after 1980 when energy costs were far higher. For example, measured relative to home value, homes built since 2000 have fuel costs that are 43 percent below that of homes built during the 1960s. This is true even with home improvements having been made to many of these older homes, increasing their energy efficiency, over the last quarter century.