Global economy at risk from oil price rise

Oil policy changes as well as prices after economy is nearing recovery

The good times are back. Credit spreads are narrowing, risky assets are recovering and commodity prices are bouncing back up. Even London house prices have posted a couple of months of positive returns. Those fearful of a repeat of the Great Depression have now been silenced by gigantic monetary and fiscal policy responses. Policy seems to be working and liquidity is coming back into the system.

More importantly, the fastest acceleration in global money supply since the Asian crisis is also helping to repair asset values. Nevertheless, the world economy cannot sustain any further rise in the oil price, Fatih Birol, the International Energy Agency’s Chief Economist warned as oil prices rose toward a record high for the year.
Birol stated that prices higher than about $70 could dampen a world economic recovery.

“If we go one step further, if we see prices go much higher than that, we may see it slow down and strangle economic recovery,” he said of oil prices, when the European benchmark was around $70.

As long as prices go high, governments’ budget for subsidies becomes higher. Surging oil prices are forcing governments to reconsider their approach to subsidies and taxation, which may cause more rises of price to be passed on to the consumer. Higher prices at the pump make a difference to Asia and the Middle East’s relentless increase in fuel demand. These facts lead to the crude oil politics to change according to the prices rate.

Last month, European oil reached a high for the year of $73.75, spurred by manufacturing data from China and construction data from the U.S.
Fears have been raised over recent months that the inflationary effect of higher energy prices could impact the monetary measures taken by western governments to get their economies out of recession.

Nicolas Sarkozy, French President, and Gordon Brown, UK Prime Minister, called for better scrutiny of energy markets at the G8 meeting two months earlier in Italy, and the U.S. commodities regulator began hearings three weeks ago that are likely to result in more limits on oil futures trade. UK regulators are also considering whether energy futures markets are adequately controlled.

However, Birol said that efforts to curb oil speculation were “a good step”, but were not going to significantly reduce prices.
Mr Birol said poorer countries such as those in sub-Saharan Africa would be particularly hurt by higher energy prices. “They will go through a . . . vicious circle of debt as they did a few years ago in order to finance their oil imports,” he said.
The real problem, he said, was declining investment in oil production, which if anything had worsened in recent months.
He said Chinese demand would be an important determinant of oil prices, and the worldwide supply and demand balance could become very tight if other countries began to grow in 2011 or 2012.  

And the dollar did fall against the euro to end the week, effectively making dollar-based oil cheaper across the globe. That created its own momentum and drew a lot of investor money into crude, meaning the price for gasoline and other fuels will likely move up as well.
Lower prices of oil and other commodities late last year was probably more beneficial to the global economy than any government stimulus effort. This whole recovery is based on more liquidity being added to the system, when in fact the problem is we didn’t have enough oil.


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