Can Oil Slow Down the World Economy?

Since January, crude oil prices have risen by about 50 percent and it is very likely that they will achieve the level of $100 per barrel by the end of this year.

WTI Crude Oil reached $92 amid US sanctions against Iran, Turkish military intervention in Iraq, a rebel attack on a oil rig in Nigeria, fall in crude oil inventories and unprecedented weakness in the U.S. dollar. Despite the recent supply increase by OPEC and the announcement they will do it again on November by 500,000 barrels a day, prices are likely to rise further.

Can the effect of oil prices increase be significant for the global economy? Yes and no. In the past, high oil prices led for two times to bear markets and severe recessions in the developed world, reaching three times $100 inflation adjusted level. However, this time it seems that the increase in oil prices may only have a considerable influence on U.S. economy since a weak dollar makes other countries less vulnerable to the surge in energy prices.

Oil price inflation has not outstripped economic growth, according to Veronique Riches-Flores of Société Générale. In her research, she uses the concept of the oil burden” - the proportion of the world economy devoted to buying oil which is the volume of oil consumed multiplied by the average price and divided by nominal gross domestic product. Oil was very cheap in the late 1990s and in this decade before the invasion of Iraq triggered the long-term rise in crude prices. With the world economy growing steadily, the oil burden at the end of the second quarter of this year was well below the level it touched in the middle of last year (when high oil prices did appear to weigh on the stock market). It was no higher than the levels seen in 2005. If prices are sustained at around their current levels, or even move forward to $100, then, she says, the most recent trends in crude oil prices might be more difficult to absorb.

A good reason for concern is that oil production seems to be declining, according to a newly published global oil supply report to be presented by the Energy Watch Group. World oil production peaked in 2006, the report said and by 2020 global oil supply will be noticeably lower. This will create a supply gap which can hardly be closed by growing contributions from other fossil, nuclear or alternative energy sources in this time frame.


Anna Fedec, Source: Financial Times
10/28/2007 5:07:30 PM