World oil prices continued rising overnight Thursday, topping $US110 a barrel in New York, and jumping more than 2% to more than $US127 a barrel for Brent crude in London.
For more an more analysts, the rise in global prices is starting to sound warning bells for the sluggish world economy, and especially those in the US and Europe.
AMP Capital investors Chief Economist, Dr Shane Oliver assesses the return of high oil and petrol prices.
World oil prices are rising again. Since its low last October, US West Texas Intermediate is up 40% and Asian Tapis oil prices (which drives Australian petrol prices) are up 18%.
Last year a similar surge in the oil price left global growth weak and vulnerable to European and US debt scares in the September quarter. So what is the risk this time around?
What’s behind the latest surge in oil prices?
The latest surge in oil prices reflects three key developments. First, we are seeing a long term structural rise in oil demand in the emerging world on the back of rapid industrialisation in key countries, including China.
This likely has much further to go as annual oil consumption is just 2.5 barrels per person in China and just one barrel per person in India compared to around 15 barrels per person in Australia and 24 in the US.
So while oil demand growth is weak in developed countries reflecting poor growth, energy efficiencies and the growth of alternatives it remains strong in the emerging world. See the previous chart.
As a result the developing world now accounts for a greater share of world oil consumption than do developed countries.
As the Peak Oil crowd have been pointing out for years growth in demand for oil is exceeding that of new supply.
The end result has been a rise in the equilibrium price of oil.
OPEC countries appear to be reinforcing this as falls in the oil price below $US100 a barrel have been met with supply cutbacks as OPEC countries seek to maintain their revenue flow in order to fund stepped up public spending.
Secondly, oil prices have benefitted from an improvement in the global growth outlook.
This has been seen in most growth assets – shares, commodities, the $A – which have all rebounded over the last few months and oil has been caught up in this.
This has been accentuated more recently by a renewed fall in the $US, since oil is priced in US dollars.
Finally, we have seen a renewed rise in the geopolitical risk premium associated with tension in the Middle East.
Iran is at the centre of this with western countries moving to impose an embargo on Iranian oil and Iran in turn threatening to close the Strait of Hormuz.
At the same time the civil war in Syria is worsening bringing with it the risk of western intervention which in turn runs the risk of further inflaming tensions in the Middle East as Syria is an Iranian ally.
Syria not a big oil exporter, but Iran exports roughly 2.5 million barrels a day compared to global oil production of 90 million barrels a day, posing a bigger threat than Libya last year which exported 1.5 million barrels a day.
This can be made up for by Saudi Arabia which has roughly 2 million barrels a day of spare capacity.
A bigger problem would arise if Iran did “close” the Strait of Hormuz as some 16 million barrels (or 18%) of world oil production flows though it each day.
The question then becomes how far Iran is prepared to go before it backs down.
Economic pressure on Iran is mounting and the current Iranian regime would probably not like to go the way of Sadam Hussein’s Iraq or Colonel Qaddafi’s Libya.
Then again I am not a Middle East political expert.
Oil prices and the global economy
What happens if the situation regarding Iran continues to escalate?
Past oil price surges have clearly played a role in triggering US & global downturns. See the next chart.
It’s not so much the oil price level that counts as its rate of change, as businesses and consumers get used to higher prices over time.
Trouble normally ensues if the oil price doubles over 12 months and we are nowhere near that – West Texas Intermediate (which is constrained by a US oil production surge and transport constraints) is up 10% year on year,
Brent is up 9% and Tapis is up 15%.
US household spending on energy as a share of income is not historically high and the oil price surge has occurred when the labour market is improving.
Our view is that the world can probably live with West Texas Intermediate at around $US110 a barrel (or Brent around $US120).
The following table estimates the impact on GDP of a $US10 rise in the price of oil for the year ahead in the second column and then applying that to the impact of oil at $US120 a barrel and $US150 a barrel.
Global growth this year is currently forecast to be around 3% so if the world oil price (WTI) settles around $US120 a barrel then global growth would be reduced to around 2.6%, i.e. soft but not disastrous.
However, a sustained spike to $US150 a
