The credit crunch has weakened the world economy, but not led to a global recession; but there’s a growing risk that the surging oil price will, according to the AMP’s chief strategist and economist, Dr Shane Oliver.
He says that while long term trend in the oil price will remain up with $US200 a barrel likely some time in the next few years, current prices are not justified by oil supply & demand and are likely to fall back – probably to around $US100 a barrel – sometime in the next six months.
He says the risk is high that oil prices will send the global economy into a slowdown.
In the last few days oil prices have spiked to a new record of nearly $US139 a barrel. This is roughly double year-ago levels and nearly thirteen times above their 1998 low point.
Growing risks for the global and Australian economies
The ever rising world oil price is now posing a major threat to the economic outlook. The threat to inflation is already apparent and inflation rates in most countries are now running well above year-ago levels. It is also leading to higher interest rates than would otherwise be the case in the face of slowing economic growth.
The continuing surge in oil prices will complicate the setting of interest rates in Australia because it’s quite conceivable that the latest spurt in oil and petrol prices will push headline inflation up to 5%.
But more importantly at a time of weak economic conditions is the “tax” on consumer spending that higher oil prices are resulting in and likely pressure on corporate profit margins as weakening consumer spending will make it hard for companies to pass on oil related cost increases.
While the US credit crunch and housing slump have not been enough to bring on a global recession, it seems as if the oil market is determined to do so.
At current oil prices, world oil spending expressed relative to global GDP is well above the levels that created problems for global growth in the early 1980s. And it is increasing faster than occurred in the 1970s, having almost doubled in the last year. (See chart below).
Coming at a time when global growth is already slowing rapidly and consumers & businesses are already struggling, the latest surge in the oil price is significantly increasing the risk of global recession (defined as global growth below 3% pa), the probability of which we would put at about 40%.
For Australia the rise in oil prices is not as bad as in many other countries because it has been accompanied by a rise in commodity prices and this has boosted Australia’s national income.
However, for most Australians this boost (reflected in higher returns from resources shares, income tax cuts and lower import prices from the strong $A) is being more than offset by higher interest rates and, more significantly, higher petrol prices.
The latest surge in oil prices if sustained will see Australian petrol prices rising above $1.70 a litre over the next week or so.
This will see the weekly petrol bill for a typical Australian family reach about $75, $20 a week up on a year ago.
This is an extra $1000 a year which is on top of higher mortgage payments, which means less spending on other things.
While the risk of recession in Australia is below that in the US, Europe and Japan, the risk is now significant thanks to high interest rates and surging petrol costs. There is also a growing risk that the rise in oil prices both indirectly (via slower rich country growth) and directly starts to drag down growth in China and the rest of Asia which will have an adverse impact on demand for Australian exports.
The risk of recession in Australia is now probably around 30-35%, and our assessment is that the RBA should and will give more weight to this as opposed to the short term inflation threat flowing from higher oil prices and hence leave interest rates on hold.
Demand and supply fundamentals support high oil prices, but not this high
Our assessment has been and remains that with global demand likely to continue trending up as countries like China and India industrialise and in the process use up more energy, oil supply will struggle to keep up in the absence of higher prices.
So the long term trend in the oil price will remain up and it’s likely we will see $US200 at some point in the next few years.
However, the surge in oil prices this year is being driven by a range of factors over & above normal supply and demand influences, including:
- Increased global pension fund demand for commodities, including energy, as another asset class. This has been fuelled by the low correlation of commodities to other investments, and has been given a boost by strong gains in commodity prices as shares, credit and property have been struggling.
- The slide in the $US which has pushed up the value of commodities, such as oil, which are priced in $US and raised their demand as a hedge against a falling $US.
- In the last few days a premium for geopolitical risk has been built back into the oil price on concerns Israel may bomb Iranian nuclear facilities.
It’s doubtful these factors adequately explain the 40% plus surge in oil prices s
