Oil has room to rise before recession kills demand

Oil could climb well above $150 a barrel before it tips the developed world into recession
Oil has room to rise before recession kills demand
BLACK GOLD: Oil price spikes caused by supply disruption have been the more usual trigger for economic collapse (Getty Images)
By Reuters
Thu 14 Apr 2011 01:11 PM

Oil could climb well above $150 a barrel before it tips the developed world into recession, leaving some scope for producer nations to carry on earning petrodollars without destroying fuel demand.

Representatives of consumer countries have said prices are already high enough to dent fuel use, although the International Energy Agency and OPEC both kept their 2011 oil demand growth forecasts unchanged in reports this week.

The rule of thumb for an increase that would cause a recession, with major implications for fuel demand, is an annual surge of 100 percent, according to some analysts, which would take the market well above the 2008 record of $147.27 for US crude.

"The danger is that if prices keep rising, any growth slowdown will be more severe, leading to a great chance of recession. This has been common following 100 percent oil price rises," said Richard Batty of Standard Life Investments.

So far the rise has been less than half of that.

Brent crude, which has led the current rally, hit a two and a half year high of just above $127, up 49 percent, from a year ago and about 40 percent higher from the end of 2010.

Other pointers, used by Batty and other economists, are that each $10 per barrel rise, if sustained, adds 1 percent to inflation and shaves 0.5 percent off gross domestic product.

Although many said it was difficult to say precisely where the danger level would be, many agreed there was scope for further rises before recession kicks in.

Even the International Monetary Fund, which has flagged oil prices as a threat, has said it sees no recessionary risk yet.

"The magnitude of the actual oil supply shock has, in historical comparison, been moderate to date," it said in its World Economic Outlook published on Monday. "Although these (price) increases conjure up the spectre of 1970s-style stagflation, they are unlikely to derail the recovery."

Nariman Behravesh, chief economist at IHS Global Insight, said oil would have to climb above the range of $150-$160 before it halted the "fair amount of momentum" in the world economy.

There is already anecdotal evidence this year's oil rally has left some households seeking to limit fuel use, but the price shock of 2008 and previous spikes have hardened consumers.

"The question is whether today's oil prices can be considered a shock when you have seen them before. In 2008 we spent nearly seven months above $100 a barrel," said Lawrence Eagles of JP Morgan.

"The 1970s show that consumers can become accustomed to higher price levels and that economic growth can rebound in a high price environment."

The first 1970s price shock is still the greatest in living memory, when oil nearly quadrupled in response to an Arab oil embargo.

It was followed by a second shock at the end of the decade and beginning of the next caused by the Iranian Revolution and then Iraq's invasion of Iran.

Developed economies as a result changed their behaviour to become more energy efficient and less vulnerable to price rises.

Emerging economies are still striving to balance economic growth with fuel efficiency and gradually to remove subsidies that have made energy cheap and encouraged high consumption.

China, the world's biggest energy user and second-biggest oil consumer after the United States, has increased retail fuel prices by 5-5.5 percent to record levels, but that is expected to have a minimal impact as those rich enough to buy a car in China can still afford fuel.

"No matter whether from actual fuel consumption or indicators of oil product sales, I didn't see a substantial decline in oil demand," said Dai Jiaquanm, a senior researcher with state-owned Chinese National Petroleum Corporation.

The 2008 recession was largely caused by a credit crunch. The collapse in energy demand cannot straightforwardly be blamed on expensive oil.

Oil price spikes caused by supply disruption have been the more usual trigger for economic collapse.

This year's rally has been driven by a relatively modest shortfall. OPEC member Libya had pumped around 1.6 million barrels per day (bpd) until violence shut in most of its output.

Other OPEC members have enough spare capacity to compensate.

Behravesh of IHS Global Insight contrasted the lost Libyan output as a percentage of today's global supply with the disruption caused by the Iran-Iraq war, starting in 1980, which cut off roughly 8 million bpd.

"That would be the equivalent of about 12-15 million bpd now. To see the same impact we would have to see Saudi Arabia or Iran shut down," he said. "Libya on its own isn't enough."

Saudi Arabia alone has more than 3 million bpd of spare capacity but has made clear it will pour extra oil on the market only if there is demand for it.

Analysts have also said Riyadh could be more comfortable than usual with higher prices as it seeks revenue for social spending plans to help stifle potential unrest.

Its relatively muted response is in contrast to 2008, when the pace of the oil market rally combined with a credit crunch that threatened to cripple the world economy, prompted Saudi Arabia to summon an emergency meeting and state it could increase its spare capacity if necessary.

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