The gradual disintegration of Libya, coming after the collapse of the regimes in Egypt and Tunisia, plus demonstrations in Algeria, Bahrain, Yemen and talk of unrest on Saudi Arabia has combined to send oil prices higher.
The AMP’s chief strategist and economist, Dr Shane Oliver looks at expensive oil and what it means.
Oil prices are surging again. While US West Texas Intermediate is lagging due to high US stock piles, North Sea Brent and Asian Tapis oil prices are back above $US100 a barrel for the first time since September 2008.
Increasing unrest in North Africa and the Middle East has been a key driver of the latest spike.
After President Mubarak of Egypt resigned there was optimism amongst global investors that major disruption to the world supply of oil could be avoided.
However, unrest has continued to spread throughout the region notably to Bahrain and Libya, raising the risk of a disruption to global oil supplies.
Libya accounts for 1.8 million barrels a day of oil production and has already seen disruption to oil production and exports.
Algeria, which has also seen protests, accounts for 2.1 million barrels a day.
These two countries alone account for 4.6% of world oil production. Iran, which has also seen some unrest, accounts for another 4.2 million barrels a day.
Iran’s decision to send naval ships through the Suez Canal has only added to tensions in the region.
The unrest in the Middle East could be a positive world changing event like the collapse of the Berlin Wall, but who knows yet which way it will go, and the tail risk of an escalation seriously threatening oil supplies is high enough to keep investors nervous.
This in turn has pushed up oil prices sharply.
The unrest in the Middle East has really just added to what is a tightening oil market. Global oil demand slumped in the recession of 2009.
However, the global recovery, particularly stronger growth in the US which is still the world’s largest oil consumer, has returned us to the basic problem that was apparent in the years before the global financial crisis.
That is, the underlying growth rate in demand for oil is exceeding the ability of supply to keep up.
This is illustrated in the next chart which shows the long term uptrend in global oil consumption against the long term downtrend in global oil discoveries.
The failure of the oil price to go anywhere near its previous lows in 2008-09 during the biggest slump in world GDP since the 1930s highlights the extent of the supply constraint for oil.
On current demand projections spare global oil capacity will have been depleted in three years.
While I am not in the Peak Oil camp that sees an imminent peak in global oil production resulting in economic chaos, the outworking of all of this is higher oil prices.
Implications for the global economy
My view has been that the world oil price will rise above $US100 a barrel this year on the back of strong demand growth relative to constrained supply.
The turmoil in the Middle East has simply brought this forward.
The world could probably live with $US100 oil, as consumers and businesses are now used to it.
Just like Australians now assume that petrol prices north of one dollar a litre are normal.
It would still leave world spending on oil well below its 2008 peak.
However, a continuing surge in the oil price – particularly if unrest in the Middle East spreads – could start to be more of a dampener on growth.
Of course, rising oil prices will add to the inflationary boost already flowing through from higher food prices.
However, rising oil prices like higher food prices also act as a tax on growth, as it cuts into discretionary spending power.
This is particularly so in Asia where the oil intensity of GDP is generally greater than that in developed countries.
So it’s too early to get overly worried now but if the oil price continues to surge then it will become more of a problem.
For Australia, the strong Australian dollar is acting as a bit of a buffer against the rising oil price, but unless the $A goes up one for one, which seems unlikely, then the protection is partial.
Australian petrol prices have already risen above the $1.30 a litre level and if the Asian Tapis crude oil price stays around current levels then a further rise in the weekly average petrol price to around $1.45 a litre is likely.
This will add to the boost to inflation already flowing from the floods. However, as with the flood related boost to inflation, the RBA is unlikely to respond, focussing more on underlying measures of inflation, which are likely to remain benign for now.
More fundamentally, another 10 cents per litre increase in the petrol price will see the weekly petrol bill for a typical Australian family reach about $65, still down from the 2008 peak of $74 a week but up $10 a week from a year ago.
This will add to the boost to inflation already flowing from the floods. However, as with the flood relat
