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2012-03-13 07:02:18
Mar 10th 2012 | Washington, DC | from the print edition
WITH the euro crisis in abeyance, high oil prices have become the latest source
of worry for the world economy. Oil is the new Greece is a typical headline
on a recent report by HSBC analysts. The fear is understandable. Oil markets
are edgy; tensions with Iran are high. The price of Brent crude shot up by more
than $5 a barrel on March 1st, to $128, after an Iranian press report that
explosions had destroyed a vital Saudi Arabian oil pipeline. It fell back after
the Saudis denied the claim, but at $125, crude is still 16% costlier than at
the start of the year.
Assessing the dangers posed by dearer oil means answering four questions: What
is driving up the oil price? How high could it go? What is the likely economic
impact of rises so far? And what damage could plausible future increases do?
The origins of higher prices matter. Supply shocks, for instance, do more
damage to global growth than higher prices that are the consequence of stronger
demand. One frequent explanation of the current rise is that central-bank
largesse has sent oil prices higher. In recent months the world s big central
banks have all either injected liquidity, expanded quantitative easing
(printing money to buy bonds) or promised to keep rates low for longer. This
flood of cheap money, so the argument goes, has sent investors into hard
assets, especially oil. But since markets are forward-looking, the announcement
rather than the enactment of QE should move oil prices; indeed, the chairman of
the Federal Reserve, Ben Bernanke, disappointed markets last month by not
signalling another round of QE (see Buttonwood). Moreover, if rising prices are
being driven by speculators you should see a rise in oil inventories exactly
the opposite of what has happened.
Central banks may have affected oil indirectly, by raising global growth
prospects, which in turn buoy expectations for oil demand. Circumstantial
evidence supports this thesis. The recent rise in oil prices has coincided with
greater optimism about the world economy: a euro-zone catastrophe and a hard
landing in China both appear less likely and America s recovery seems on
stronger ground.
But slightly rosier growth prospects are only part of the story. A more
important driver of dearer oil has been disruptions in supply. All told, the
oil market has probably lost more than 1m barrels a day (b/d) of supply in
recent months. A variety of non-Iranian troubles, from a pipeline dispute with
South Sudan to mechanical problems in the North Sea, have knocked some 700,000
b/d off supply. Another 500,000 b/d or so of Iranian oil is temporarily off the
market thanks both to the effects of European sanctions and a payment dispute
with China.
The cushion of spare supply is thin. Oil stocks in rich countries are at a
five-year low. The extent of OPEC s spare capacity is uncertain. Saudi Arabia
is pumping some 10m b/d, a near-record high (see chart 1). And there is the
threat of far bigger supply disruptions if Iran were ever to carry out its
threat to close the Strait of Hormuz, through which 17m barrels of oil pass
every day, some 20% of global supply. Even a temporary closure would imply a
disruption to dwarf any previous oil shock. The 1973 Arab oil embargo, for
instance, involved less than 5m b/d.
Separating out these various factors is not easy, but Jeffrey Currie of Goldman
Sachs reckons that the fundamentals of supply and demand have pushed oil prices
to around $118 a barrel. He thinks the remaining increase is down to fears
about Iran. If so, should relations with Iran improve, the oil price might go
down by a few dollars, but stay close to $120.
Globally, the damage from price increases to date is likely to be modest. A
rule of thumb is that a sustained 10% rise in the price of oil shaves around
0.2% off global growth in the first year, largely because dearer oil shifts
income from oil consumers to producers, who tend to spend less. For now any
impact is almost certainly outweighed by improvements elsewhere, particularly
in the easing of the euro crisis. Despite dearer oil, the prospects for global
growth are still better than they were at the beginning of the year.
But the impact on growth and inflation in individual countries will differ. In
America, a net importer which taxes fuel lightly, the standard rule is that a
$10 increase in oil prices (which corresponds to a 25-cent rise in the price of
petrol) knocks around 0.2% off output in the first year and 0.5% in the second
year. That would slow, but hardly fell, an economy that is widely expected to
grow by more than 2% this year.
There are in any case several reasons why America may be more resilient to
dearer oil than in recent years. The jump in petrol prices has been far smaller
than in 2011 or 2008. Rising employment gives consumers more income with which
to pay for fuel. And America s economy is becoming ever less energy-intensive,
and less dependent on imports. Oil consumption has fallen in the past two
years, even as GDP has risen.
Americans are driving less, and they are buying more fuel-efficient cars. Net
oil imports are well below their 2005 peak, which means more of the money
Americans spend on costlier oil stays within its borders. The development of
copious amounts of natural gas means gas prices have plunged. That, coupled
with an unusually mild winter, has kept bills for home heating unusually low.
In January the share of consumers spending on energy products was the
second-lowest in 50 years. These factors do not imply that America is
impervious to spiking oil, but they do suggest the impact of price rises to
date will be modest.
Europe is more exposed. European countries, which tax oil more heavily than
America, have typically seen a smaller impact on growth from changes in the oil
price. But this time they may be relatively more affected, because most
economies are already stagnant or shrinking. Worse, Europe s weakest peripheral
economies are also some of the biggest net importers (see chart 2). Greece, for
instance, is highly dependent on imported energy, of which 88% is oil. Even the
price rises to date will worsen the euro-zone recession; a big jump could spawn
a deep downturn and fracture the confidence of markets.
Britain is relatively insulated. Although it is a net oil importer, it has
significant resources in the North Sea. Any losses to the consumer from dearer
fuel are partially offset by gains in the oil and gas sector itself. But even
in Britain the net effect of price increases to date could be more damaging
than usual, particularly since they reduce the odds of sharply falling
inflation. Lower inflation, and a rise in real incomes, are one reason British
policymakers hoped to see the economy improve this year.
Barrels, no laughs
In emerging economies the picture is even more disparate. Oil exporters, from
Venezuela to the Middle East, are gaining; oil importers will see worsening
trade balances. In 2008 and 2011, the main effect of dearer fuel in emerging
economies was on inflation. That is less of a worry now, largely because food
prices, which make up a much bigger part of most emerging economies
consumption basket, are stable.
But some countries will face problems. In the short term, some of the
hardest-hit emerging economies will be in eastern Europe. They will suffer not
only from more expensive oil but also from the weakening of European export
markets.
India is also a concern. Fuel is a big component of its wholesale-price index,
for example, so inflation will rise as higher oil prices are passed through to
domestic fuel costs. To the extent they are not, the budget will be hit. India
regulates and heavily subsidises the price of diesel and kerosene. According to
Deutsche Bank, diesel prices have risen by only 31% since January 2009, whereas
the price of crude oil in rupees is up by 180%. The difference is a result of
subsidies, frustrating India s efforts to reduce its budget deficit.
So oil is not the new Greece. More expensive oil is, for now, doing little harm
to global growth. But it is not helping Europe s more fragile economies. And if
the Strait of Hormuz is threatened, the resulting surge in oil prices will
spell the end of the global recovery.
from the print edition | Finance and economics