April 29, 2005

How Much Will Record-High Oil Prices Hurt Global Growth?

If oil prices do shoot up to $80 per barrel—and stay at that level for one or two quarters—the global economy will likely reach a “tipping point.” In such a scenario, growth in the US economy would be cut to less than 2%, while Japan and many of the Eurozone economies would be pushed into recession. In such a scenario, the Chinese economy would also experience a rapid deceleration.


by Nariman Behravesh
http://www.globalinsight.com/

Major risks remain in the oil price outlook. After all, the rise in oil prices has been driven by strong demand growth, not by supply interruptions. Global oil supplies remain stretched, and—so far—higher prices have not produced a major demand-side adjustment. The risk is that oil prices may have to keep rising until they do produce a demand-side response, by slowing the global economy sharply and by making demand growth less oil-intensive.

Global Insight has recently revised upward its oil price outlook to reflect market expectations that the supply-demand balance in petroleum markets will remain extremely tight for the next few years. We now predict that oil prices will stay in the $50 range for the balance of this year, softening toward the end of the year as both the US and Chinese markets continue to slow. However, until new supplies come on stream (probably no earlier than two or three years from now), oil prices are unlikely to fall much below $45 per barrel.

The impact of high oil prices across the world has been very uneven. The effect on the US economy has been fairly limited, thanks to strong growth momentum, macro policies that are still fairly stimulative, and the fact that the United States still produces roughly 40% of the oil it consumes. Likewise, Canada and the United Kingdom, as energy producers and exporters (as well as consumers), have been helped (and hurt) by the rise in oil prices. China has been largely immune because of its strong growth and the limited pass-through of high oil prices to consumers in the tightly controlled Chinese energy markets.

On the other hand, both the Eurozone and Japan have suffered. Sluggish growth, macro policies that are arguably too restrictive (especially in the Eurozone), and the reality that these economies must import any oil they consume are all to blame.

Many emerging markets have also not yet felt the pain of higher oil prices for two reasons. First, the rise in energy prices has been part of a broad-based rise in all commodities prices, which has helped these economies and cushioned the impact of more expensive energy. Also, as in the case of China, many of the governments in these countries control their markets for all energy sources and often pay fuel subsidies. This means that most consumers and businesses in these economies have not borne the brunt of the price rises—and consequently have not reduced energy consumption.

The longer oil prices stay high, the greater the likelihood that they will be passed through to consumers, by businesses in developed economies and by governments in emerging markets. This means higher inflation and slower consumer spending on other goods. Global Insight believes that, in the end, global output will be reduced by 1.0% to 1.5% this year by high energy prices.

If oil prices do shoot up to $80 per barrel—and stay at that level for one or two quarters—the global economy will likely reach a “tipping point.” In such a scenario, growth in the US economy would be cut to less than 2%, while Japan and many of the Eurozone economies would be pushed into recession. In such a scenario, the Chinese economy would also experience a rapid deceleration.

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