February 24, 2011 / 12:58 PM / 8 years ago

Analysis: Oil prices could be game-changer for world economy

LONDON (Reuters) - Soaring oil prices are reaching levels that could threaten to brake improving but tentative global economic recovery, with an outside chance of a new recession or that most destructive of conditions, stagflation.

Venezuela's President Hugo Chavez takes a sample of crude during his weekly broadcast at a nationalized oil field at Orinoco's belt in the southern strip of the eastern Orinoco River February 17, 2008. REUTERS/Miraflores Palace/Handout

If the price spike is sustained, it will soon add pressure on central banks already worried about food prices to tighten monetary policy, a move that would mop up some of the liquidity that fostered recovery in the first place.

It will also hit different regions and countries differently, depending on their underlying economic strength and whether they are oil producers or importers.

Few policymakers or analysts are panicking yet. The spiking price of oil is related to the turmoil in Libya and fears of a more widespread supply disruption. It has nothing to do with wider economic fundamentals.

But the numbers are getting high enough to at least raise the prospect of big trouble for the global economy.

Brent oil was around $115 a barrel on Thursday, hitting its highest level since August 2008, and U.S. crude was above $100. They were driven by concern the bloody unrest that has cut more than a quarter of OPEC-member Libya’s output could spread to other producers including Saudi Arabia.

The Brent contract flirted with $120 a barrel in earlier trading, a level Deutsche Bank says could be an inflection point for global economic growth.

“$120/barrel is the level that oil as a share of global GDP starts to move above 5.5 percent of GDP, which has historically been an environment where global growth has come under pressure,” the bank’s analysts said in a note.

Technical analyses indicated that oil prices could smash through their 2008 highs to just below $160 a barrel this year, according to Reuters analyst Wang Tao.


An oft-cited rule of thumb is that a $10 per barrel increase in the price of oil knocks half a percentage point from global GDP growth.

By this standard, an oil-induced double-dip recession is a long way off. Brent would have to reach around $190 a barrel for a return to negative growth from current levels.

The rule is questionable — the world economy boomed in the mid-noughties while oil soared. The key is really the sustainability of a high price.

Charles Robertson, chief economist at Renaissance Capital, for example, reckons that an average annual price of more than $150 a barrel would be akin to the oil-price shock that hit after the Iranian revolution of 1979.

That pushed oil up to nearly 8 percent of GDP, way above the level at which it starts battering global growth.

Robertson, however, says the world can handle short-lived spikes that only lift the GDP impact to 5 percent.

Macquarie economists, meanwhile, calculate that oil needs to be sustainably above $120, closer to $140, before it starts having a major global impact.

For that to occur it would probably take more than just Libyan revolt. The fear at the back of many investors’ and economists’ minds is an even wider breakdown in stability across the Arab world, particularly if Saudi Arabia was dragged in.

The latest spike in prices, for example, was partly prompted by Goldman Sachs saying that the market was reacting to fears of contagion to other producing nations after Libya and that another disruption could create severe oil shortages and require demand rationing.

All bets would be off if Saudi Arabia succumbed to serious popular revolt. The top OPEC producer holds more than a fifth of world oil reserves.

Saudi King Abdullah returned home on Wednesday after a three-month medical absence and unveiled benefits for Saudis worth some $37 billion in an apparent bid to insulate the world’s top oil exporter from an Arab protest wave.


Even if the price is relatively contained, however, any form of sustained rise will feed into already rising inflationary pressures, threatening monetary tightening and causing problems of different sorts across the world.

Fast-growing Asian economies such as China’s are already struggling to deal with higher food prices and to keep their economies from over-heating.

Deng Yusong, an economist at China’s Development Research Center, a government think tank, told the hexun.com financial news website that a higher oil price is not a particular problem for Chinese consumer inflation.

But, looking closer at the heart of the Chinese economic dragon, he added: “The impact of oil prices on the producer price index may be quite deep.”

Elsewhere, higher oil prices are threatening to unwind some of the recovery plays being carefully crafted by western officials.

Calls are already being heard for the British government to hold off on new petrol taxes, an income stream that is part of a broader plan to kill off a burgeoning fiscal deficit.

European Central Bank officials have also become increasingly hawkish about inflation, despite weak growth in a number of non-core euro zone economies.

Higher prices, meanwhile, are unlikely to do anything positive for U.S. employment, which continues to lag economic recovery elsewhere and directly impacts all-important consumer sentiment.

It is the United States that may bear the heaviest inflationary brunt from an oil shock in the developed world, according to analysis by at Fathom Consulting.

It calculates that oil at $120 would add about 0.5 percentage points to UK and European inflation but more than 1.5 points to U.S. inflation because of greater American consumption of oil and its lower energy taxes.

“An increase in oil prices then might still be a problem for all, but it is a particular problem for the Fed, especially at this point in the ‘recovery’,” said Fathom’s Andrew Clare.

A repeat of the ‘70s oil crises, which saw prices spike, global economic growth dampen and stagflation remains an extreme scenario. But it is not as obscure a prospect as it was a few weeks ago.

Additional reporting by Mike Peacock and Don Durfee

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