World Economy Winces at Oil Near $50, But Can Cope
Mon Aug 23, 2004
LONDON (Reuters) - U.S. oil futures near $50 a barrel -- almost 50 percent up on the start of the year -- are daunting for the world economy but such sky-high energy costs are unlikely to deal the current expansion a fatal blow.
Judging the impact of soaring oil prices in isolation is a always tricky and the existing momentum of the world's largest economies is critical in assessing how they absorb it.
But, although supply distortions and geopolitical risks have exaggerated the most recent price spike, the big driver remains the sheer scale of demand from a global economy set to have expanded by up to 5.0 percent in 2004 - its fastest in 20 years.
The more extreme estimates of the oil price impact -- some suggesting oil sustained at $50 could clip a full percentage point off world output -- need to be seen against that backdrop. What is more, the "shock" in inflation-adjusted prices is still below previous scares and the real price of oil is less than half its 1980 peak. Western economies are also far less oil dependent than 30 years ago and net oil imports accounted for less than one percent of total output by 2002.
Arguments also start to be become circular at this point. If $50 per barrel oil is set to push the world's leading economies back toward recession, then a fundamental justification for oil at these levels should fade anyway and lower prices will ensue.
"To say that the oil per se would tip the OECD economy back into recession is an exaggeration at this point in time," said Vincent Koen, senior economist at the Paris-based Organization for Economic Cooperation and Development.
The doomsayers, on the other hand, argue oil may be enough to tip a wobbly world over the edge.
The say rules of thumb from recognized economic models probably underplay the impact high and rising oil prices have on the confidence of businesses and consumers and indirect fallout from the reactions of risk-averse financial markets.
Some also argue that despite high levels of real economic growth, an oil spike will deal a disproportionate blow to a world economy cooling from peaks rather than one that is accelerating. And others add that the vulnerability of indebted U.S. consumers to energy spikes may multiply the effects on other countries.
But most feel the global economy can take this punch on the chin. Sustained prices at these levels would certainly take a toll, but one that is just about containable.
"If the world recovery were to falter it would probably not be just because of oil -- even though oil may well be part of that picture," the OECD's Koen added.
The think-tank for the 30-nation OECD -- which does not include emerging economic giants such as China and India -- looks at Brent futures, which last week peaked near $45.
It said its region-wide 3.4 percent growth forecast for 2004 and 3.3 percent for 2005 is based on average oil prices of $32 per barrel -- up from an average 2003 price of $28.8.
That suggests that if $45-$50 per barrel Brent were to be the real average for this year, output would be less than a half point lower.
But average Brent prices so far this year have averaged $34.7. While marking a substantial 20 percent rise, it is still less than $3 above the average price assumed in OECD forecasts.
For oil to even average $10 higher this year compared to 2003, the current spot price would have to remain here or higher for the rest of the year.
Given some analysts reckon as much as a $10-15 of the oil price is accounted for by heavily discounted geopolitical and supply risks, and given the world economy is already cooling, the risks to forecasts assuming such an oil price appear large. Koen at the OECD also stressed the "ready reckoners" used in existing world growth forecasts assume all other things to be equal. He added that new forecasts for the 30-nation area would also have to take into account that since the OECD May Outlook was published, European and Japanese growth estimates for the year have probably been pushed higher.
Economists at HSBC said key determinants of the oil impact on the economy remained what and who is driving the price higher. They estimate 80 percent of the price rise to May could be explained by strong global demand -- with Asia driving 45 percent of the rise in global consumption over the past three years.
The most recent rises, they said in a recent note, are more worrying because of their geopolitical and structural nature.
And, with the rise of demand from a boom in Asia's economic giants acting like a supply shock on the developed world, they said the impact on growth could be harsh -- citing estimates of between 0.3 and 0.9 percent off world output.
Economists at Goldman Sachs argue that U.S. oil futures sustained at $50 per barrel -- compared to the $25 seen in 2002 -- would mean a loss of net income of 0.9 percent for the OECD.
But, crucially, much of the loss since 2002 may have already been absorbed and sustaining $50 oil prices remains a big "if."
Stephen Roach, chief economist at Morgan Stanley, was even more gloomy when he told clients in a note last week that the oil price surge was a shock that would exaggerate current weaknesses in the U.S. economy to threaten recession in 2005.
But he too acknowledged holding current prices was now key.
"Duration obviously matters -- the price has to stick at these levels for 3-6 months to qualify as a legitimate shock," Roach said. "But the first condition has now been satisfied - the oil price is firmly in the danger zone."
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